Towards more agile stress testing: Revamped BoE approach to stress testing the UK banking sector

The Bank of England (BoE)’s updated approach to stress testing for the UK banking system is intended to ensure that BoE-led stress tests are more predictable and adaptable. The BoE also hopes its revised approach will create opportunities for UK banks and building societies to improve their risk management capabilities¹. As Nathanaël Benjamin, Executive Director of the Financial Stability Strategy and Risk at the BoE, highlighted in his recent speech², these revisions represent “a considerable efficiency gain”. 

In this blog, we will provide a summary of the key changes to the stress testing approach for UK banks, as well as the opportunities and challenges the new regime presents to banks³.

A. Key changes

Updates to frequency of core stress test but objectives remain unchanged

Under the updated approach, the Annual Cyclical Scenario (ACS) will switch to a biennial Bank Capital Stress Test (BCST). This means the core stress test will only be run in odd numbered years (e.g. 2025/27/29…). However, the shift from a deposit-based to a total lending-based threshold for inclusion means there will be no change in the banks required to participate in stress testing. And, since the threshold correlates with the overall size of the UK economy, this will make it increasingly challenging for smaller, organically growing institutions to meet the criteria. Consequently, the list of banks required to submit to UK stress testing will likely only change through significant mergers or acquisitions.

Like the ACS, the BCST will act as a core regulatory exercise to stress test the largest UK banks against cyclical risks tied to the financial cycle and will continue to inform the calibration of capital buffers. Table 1 below shows a detailed comparison of the ACS and BCST regimes, as well as the accompanying rationale for change.

New lighter-touch stress testing in ‘off’ years

For even numbered years, in place of BCSTs, the BoE has proposed a lighter touch exercise. Currently, they have kept their options open in terms of what this might look like, but the intention is twofold. Firstly, it will aim to be less burdensome to the banks than the ACS, and secondly it will generate broader insights. Examples under consideration include desk-based exercises, multiple scenarios, targeted exercises, and exercises based on banks’ Internal Capital Adequacy Assessment Processes (ICAAPs). The matter of whether BoE will run these exercises internally, or in combination with the banks, is also to be decided.

Exploratory exercises remain and continue to focus on risks not linked to the financial cycle

Unsurprisingly, the BoE has kept exploratory scenarios focussed on structural and emerging risks as a complement to the core BCST. These exercises seem set to be less regular than before given they have lost their ‘biennial’ title. The Bank did not set out any details around the timing or nature of the exploratory exercises but did flag climate risk as an example of the structural risks that such exercises might explore in the future.

More focus on sensitivity analysis across all stress tests to better align with an ever-changing risk landscape

The BoE also emphasised the use of supplementary and sensitivity analysis to complement its three stress testing exercises. The unknown and dynamic nature of these extra requests will ensure stress testing remains adaptable. However, it is also likely to challenge banks’ operational readiness to respond.

Table 1: Summary of changes to stress testing banks

Source: Deloitte experience

B. Key Takeaways for Banks – Our Insights

Potential efficiency gains

The BoE’s overhaul of the ACS framework sets the stage for operational efficiency gains for both the regulator and participating banks. Transitioning to a two-year cycle for comprehensive stress tests should, for example, alleviate the intensive year-on-year resource demands previously associated with the ACS. Banks may also see this as an opportunity to allocate resources in ‘off’ years to non-BCST production activities. This gives banks breathing space to reallocate resources toward other risk management and strategic initiatives, including those linked to internal/management stress testing. Banks will also have an opportunity to invest in, and enhance, their BCST machinery and processes.

More agile stress testing

The new approach reinforces previous BoE messages that banks should improve their internal stress testing to be more agile, both in terms of the range of scenarios being considered (e.g. import tariffs, geopolitical events, climate⁴) as well as the portfolios and exposures they apply to. For some examples, readers may wish to refer to the 2025 priority letters^5,6 published by the UK Prudential Regulation Authority (PRA). In any case, a more adaptable approach would mean banks’ internal stress testing becoming better aligned with regulatory stress testing.

This new, more adaptable approach will also demand a state of constant readiness from banks. This could shift their operational focus from periodic intensive preparation to maintaining a year-round baseline of continual stress testing analysis and readiness. Banks should therefore seek to develop the capability to execute multiple stress scenarios at the same time so they can respond quickly to regulatory and ad-hoc senior management requests. Exploratory stress tests, with their focus on structural and emerging risks, will also require broader input from various departments. Banks should therefore work now to foster cross-functional collaboration and ensure comprehensive risk coverage.

Reallocation of Expertise

The shift in emphasis from large-scale regulatory stress tests to more agile stress testing may present a challenge in terms of banks current staffing mix. There will be less focus on execution and more focus on design. For example, the need for specialist staff to analyse diverse scenarios and emerging risks may increase. Banks may need to upskill teams in scenario development and stress testing modelling, implementation, and analysis. To handle more dynamic and potentially bespoke testing approaches, banks will therefore need to look at their investments in automation and scenario-building tools.

At the same time, despite a reduction in overall frequency, banks will still have to maintain their capacity to deliver the BCST every other year. Banks otherwise risk losing the accumulated knowledge and expertise required to effectively execute complex regulatory stress tests, especially those developed and refined over several years. In this case, banks should look for the synergies between the people and systems they use for stress testing to ensure they can deliver for both agile stress tests and other regulatory exercises.

Stress Testing Integration

With the BoE shifting its emphasis to relying more on banks’ internal capabilities, banks will have the opportunity to switch to using stress testing for business and risk management rather than a regulatory box-ticking exercise. As stress testing becomes more agile it will become more compatible with business use. Firms should ensure they have appropriate internal/management stress testing programmes in place to ensure scenario analysis is embedded in the business to support effective decision making e.g. pricing and product design.

More focus on Internal Capital Adequacy Assessment Process (ICAAPs)

In its updated approach to stress testing, the Bank also mentions leveraging ICAAPs. This suggests they may take advantage of efficiency gains through the revised process to devote more resources to their ICAAP assessments. It seems likely this will mean more attention on the ICAAP for the banks outside of BCST years. Non-BCST banks meanwhile should therefore ensure their ICAAP stress testing provides a thorough assessment of the risks facing the bank, using scenarios appropriately tailored to their individual business model and vulnerabilities.

If you would like to discuss what the PRA’s new stress testing approach means for your institution, please get in touch with our experts.

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References

¹ The Bank of England’s approach to stress testing the UK banking system | Bank of England

² Joining the dots - speech by Nathanaël Benjamin | Bank of England  

³ In this blog, reference to ‘banks’ or the ‘banking system’ refers to banks and building societies.

⁴ PMA Implementation: Don't Let Overlays Become Oversights | Deloitte UK 

⁵ Letter from Charlotte Gerken and Laura Wallis ‘UK Deposit Takers Supervision: 2025 priorities’ 

⁶ Letter from Rebecca Jackson and Alison Scott ‘International banks Supervision: 2025 priorities’