Bank of England to review lending standards as household debt soars

The Bank of England has revealed plans to review banks' lending standards amid soaring household debt as it sets out its latest overview of the UK's financial stability.

Officials also indicated that they would oversee lenders' readiness for a disorderly Brexit in the latest statement from the Bank's Financial Policy Committee (FPC).

It came as the FPC set out the scenarios that banks will face when they undergo stress tests - expanded in the wake of the Brexit vote - later this year.

The tests - failed by RBS (LSE: RBS.L - news) last year - are essentially aimed at ensuring banks have the money and systems in place to handle sudden headwinds.

In the latest version, lenders will have to show they can withstand a drop-off in foreign investment.

The regime is based on the current level of risks, as outlined by the FPC, which has warned financial stability could be compromised as businesses start to adapt to Brexit conditions.

It said risks would be "influenced by the orderliness of the adjustment to the new relationship between the United Kingdom and the European Union" and that it would "oversee contingency plans" to mitigate these.

The FPC was also concerned about a surge in household debt, already high by historical standards, with consumer credit "growing particularly rapidly".

It said this could represent a risk to lenders if underwriting standards were weak and that the Bank's Prudential Regulation Authority (PRA) was examining the creditworthiness of new lending.

Setting out details of the stress test process, the FPC said there would be two major tests this year, for the first time.

The annual test will probe the impact of a potential drop-off in global investor sentiment after sterling collapsed and bond yields soared in the wake of the referendum.

The Bank said: "As highlighted in recent financial stability reports, the United Kingdom's large current account (trade) deficit creates a vulnerability to a reduction in foreign investor appetite for UK assets and increases in funding costs for real-economy borrowers.

"The 2017 cyclical scenario incorporates a sudden increase in the rate of return investors demand for holding sterling assets and an associated fall in sterling."

The second test was being implemented to check whether lenders could withstand pressures of ultra-low interest rates - currently hitting profitability - on one end of the scale.

The other end would see rates rising towards 4%, with house price values plunging by a third amid a global economic meltdown.

That would also take in the potential impact of competition on the larger banks from smaller rivals, the Bank said.