The same stress test but higher standards expected of big banks

The global economy shrinks by 2.4% as property prices in China, Hong Kong and Singapore crash.

Investors rush to make their portfolios less risky and, around the world, there is volatility in financial markets. Emerging market currencies plummet against the US dollar.

As the contagion around the world spreads, the cost of credit rises.

In Britain, the economy contracts by 4.7%, suffering a "particularly severe" shock. Following a dive in the pound, the Bank of England's Monetary Policy Committee is forced to raise Bank Rate to 4% at the end of 2018, while the yield on UK government bonds (gilts) surges as investors demand more of a reward for the risk of lending to the UK Government.

The yield on 10-year gilts, currently 1.4%, rockets to 6.9% during the first quarter of 2019. Inflation rises to 5% by the end of 2019.

Banks, as a result, face a rise in their funding costs. In the resulting trauma, house prices in Britain fall by a third, while the commercial property market suffers a 40% drop in values. Unemployment surges to 9.5% and, with productivity growth lacklustre, the subsequent recovery is a sluggish one.

Don't have nightmares. This isn't anything set to happen this year, hopefully, but it is the scenario that is sketched out in this year's stress tests for the banking sector carried out by the Bank of England.

It is the same scenario - one more severe than the global financial crisis - that was applied in the 2017 stress tests and, in the view of the Bank's Financial Policy Committee (FPC), "encompasses a wide range of UK macroeconomic outcomes that could be associated with Brexit".

Yet the stress tests this year will differ in several respects from last year's.

For a start, while all of the banks tested will expect to maintain a strong capital position capable of absorbing losses under this scenario, those deemed to be 'systemically important' - what might be described as too big to fail - will be held by the Bank to higher standards.

These institutions are HSBC, Barclays (LSE: BARC.L - news) , Royal Bank of Scotland (LSE: RBS.L - news) , Standard Chartered (BSE: 580001.BO - news) , Lloyds Banking Group, Santander UK (LSE: 44RS.L - news) and the Nationwide Building Society (LSE: NBS.L - news) .

Explaining this, the Bank said today: "In previous tests, systemic banks that did not meet the higher standards expected of them, but that remained above their minimum capital requirements in the stress test, were permitted to take less intensive actions.

"In a real stress, capital buffers to reflect systemic importance are, like all other capital buffers, useable to absorb losses.

"Their inclusion in the stress-test hurdle rate ensures that systemic banks could withstand a real stress that is even more severe than that against which they are assessed in the test. That reflects the additional costs their failure would impose on the wider economy."

The Bank said this year's tests will also reflect a change in accounting standards called IFRS 9, introduced in January, which obliges the banks to provision for losses earlier than in the past.

This change was made following the experience of the financial crisis to reflect the fact that, under the old rules, banks were not allowed to book a loss until it had actually happened, even if it was obvious in advance that they were going to make a loss on a particular loan.

The Bank added: "Adjustments will be made to reflect the increased loss absorbency that will result from higher provisions in stress under the new IFRS 9 accounting standard."

It said IFRS 9 would mean the capital ratios of banks were likely to fall more sharply than they did in previous stress tests - even though it would not mean a change in the overall losses incurred by a bank.

News of this year's stress tests came as the FPC published a statement following its latest policy meeting, held on Monday this week. It warned that Brexit continues to pose "material risks" to the UK's financial sector and said both the UK and the EU were not yet doing enough to reduce these risks.

It added: "The FPC re-emphasises the importance that preparations continue to be made and actions taken by relevant authorities to tackle these risks."

But the FPC also said that, in its judgement, crypto-assets like Bitcoin "do not currently" pose a material risk to the UK's financial stability.