LONDON (Reuters) - Banks in Britain may have to hold more capital than their international rivals under proposals for an annual stress test of lenders put forward by the Bank of England on Tuesday.
The BoE spelled out how it will begin checking for the first time that banks do not pose risks to the UK economy by being short of reserves, both individually and as a sector.
It will start an annual test for the top eight UK lenders like Barclays, RBS and HSBC in 2014.
The test will be broadened out over five years to include big UK subsidiaries of major international banks, the BoE said.
Medium-sized British banks are likely to face a cut-down version of the test, and clearing houses could face their own health checks later on, the central bank said.
"Stress-testing can provide a quantum leap in transparency and accountability," BoE Deputy Governor Paul Tucker said.
The test will be mainly used to form supervisory approaches rather than just to identify any capital holes to plug.
"These new proposals should reinforce confidence in the financial system by letting regulators make judgments that balance systemic risk with the need to support growth," the British Bankers' Association said.
Mike Trippitt, director of banks' research at Numis Securities in London, said banks were already starting to see strong enough profits to build up capital buffers that would meet even a pessimistic stress test scenario.
At any rate, shares in Britain's biggest banks were unperturbed by the BoE's announcement, with most outperforming a rise in the broader market on Tuesday.
"The capital position of banks is pretty strong and without looking at the detail of the stress tests, what the market is saying is that these banks should be able to fare well," Trippitt said.
Analysts at Citi said uncertainty over details of the test will constrain dividends for 2013 and its lack of harmonisation with European tests may dent credibility.
But having a clear framework could in the long run reduce the "risk premium" on Britain's banks due to "ongoing concerns over regulatory creep", Citi said.
Britain, which had to rescue several banks in the financial crisis, has already required its lenders to do more to bolster their capital reserves than required under global rules and that approach looks set to continue under the new framework.
"At the very least, banks would need to maintain sufficient capital to be able to absorb losses in the stress scenario and not fall below internationally agreed minimum standards," the BoE said.
"But the level of capital that banks would need to maintain in the stress scenario could be set above strict internationally agreed minima and vary across banks."
Since the near meltdown of global markets in 2008, Britain's banks have undergone several, ad hoc stress tests to check if individual lenders hold enough capital to withstand future shocks without more help from taxpayers.
The new system proposed by the BoE in a discussion paper released on Tuesday would take a broader approach to also check the health of the banking system as a whole.
Apart from topping up capital levels, remedies could include raising margin requirements on derivatives contracts, curbing dividends and bonuses, forcing banks to shrink risky business lines and changing management.
Unlike past tests, the BoE said it intended to publish the results of its future checks, perhaps bank-by-bank, having already crossed this bridge after detailing its capital demands for named lenders earlier this year.
The bank said that in previous tests there was "insufficient engagement" by management, poor test design, discrepancies in data and too little challenge of underlying assumptions.
Under the plan, the Bank plans to use a twin approach to testing, with all banks facing a common set of stressed market scenarios and individual ones to look into their specific vulnerabilities.
The bank said this two-track system would make it harder for lenders to downplay the amount of capital they might need, a sign of how regulators want to move away from relying on in-house models used by banks to determine capital requirements.
Britain's biggest banks also face the next stress tests by European Union regulators next year, the results of which have typically been published bank-by-bank in the past.
(Reporting by Huw Jones and William Schomberg; Editing by Patrick Graham)