Lehman collapse shapes Bank of England's trading test for lenders

By Huw Jones

LONDON (Reuters) - Britain's top banks will be tested this year for their ability to cope with the type of market mayhem that followed the collapse of U.S. bank Lehman Brothers in 2008, the Bank of England said on Tuesday.

The specific test for risks from trading books will be applied to seven banks and will supplement the broader annual stress tests announced in March.

A 36 percent slide in UK blue chip shares, crude oil falling by a third, and Hong Kong shares dropping 65 percent are included in theoretical "stress" scenarios.

Bank of England Deputy Governor Andrew Bailey, who also heads the central bank's Prudential Regulatory Authority, spoke last week of the need to look more closely at markets risks in the light of recent volatility.

Regulators across the world are casting a nervous eye on bond markets, fearing there could be a stampede for the exit by investors when interest rates finally start to move off their prolonged low levels.

Bouts of extreme volatility in bond markets last autumn and in the Swiss franc this year have also served to focus minds on the question of whether banks have the capacity to cope with intense selling pressure.

"The Bank's innovations in the 2015 traded risk stress test are inspired by what has happened in real stress events, and especially in the crisis that followed the Lehman default," the Bank of England said in a statement.

Lehman's collapse froze global markets and left other banks unable to sell assets on their trading books to shore up their capital buffers, triggering painful losses that were ultimately passed on to taxpayers in many cases.

The Bank of England said the lenders being tested will have to judge how long they would take to sell specific assets during times of stress and give estimates of potential losses.

"It should be noted that banks should explain carefully the basis of the key judgments that they have made," the central bank said. "Moreover, banks' judgments will be subject to rigorous challenge from the Bank."

Trading positions on Feb. 20 this year will be used as the basis for the test, which will aim to gauge the resilience of HSBC , Standard Chartered , Barclays , Santander UK , RBS , Lloyds and Nationwide Building Society over the next five years.

Trading assets to be tested will include the dollar, euro, sterling, Swiss franc, shares, interest rates, oil, gold and government bonds from Europe, the United States and Asia.

Banks will have to maintain a core capital buffer of 4.5 percent of risk-weighed assets during theoretical stresses to pass the test, whose results will be announced in December.

(Editing by David Goodman and Susan Thomas)