The Co-operative Bank has failed a Bank of England test to see how lenders would cope with severe economic stress, which also raised concerns about state-backed Lloyds Banking Group and Royal Bank of Scotland.
The troubled Co-op must cut its loan book by £5.5bn while RBS is to issue £2bn worth of convertible bonds.
The Bank found that a severe downturn with house prices plunging 35% would wipe out the Co-op’s capital because of the effect on its risky commercial property and sub-prime home loans.
The test, using the position of banks and building societies at the end of 2013, also found RBS and Lloyds would be susceptible to such a crisis but improvements and changes to their plans this year meant only the Co-op was required to submit a new plan.
Five other lenders passed the test with no judgment by the Bank’s Prudential Regulation Authority that they needed to strengthen their balance sheet further.
Allowing for emergency “management actions”, Barclays would see its capital ratio fall to 7.5% under the scenario with HSBC scoring 8.7%, Nationwide 6.7%, Santander UK 7.9% and Standard Chartered 8.1%.
The Co-op would fall to a theoretical minus 2.6%.
HSBC and Standard Chartered, which have a major focus on Asia, are less exposed to a UK housing crisis than some of their rivals.
The RBS result comes after it suffered embarrassment following a European stress test exercise earlier this year. It initially appeared to pass with ease but later had to admit it got its sums wrong and had only scraped through.
Bank of England governor Mark Carney said following the exercise: “This was a demanding test.
“The results show that the core of the banking system is significantly more resilient, that it has the strength to continue to serve the real economy even in a severe stress, and that growing confidence in the system is merited.”
The Bank said it would review the exercise and set out plans next year for developing the stress testing framework further. Details for a 2015 test scenario will be announced next year.
With the Co-op in the early stages of its turnaround plan, chief executive Niall Booker said it was “no surprise” that the bank failed the stress test.
He added: “The bank is much stronger than a year ago. As the regulator notes today, we have achieved the target of building our capital base and the actions we have taken during the first year of our business plan have made the bank more secure for the benefit of all stakeholders.”
The Co-op is not required to raise additional capital due to the test failure but has agreed to accelerate the reduction in risk-weighted assets, particularly those residential mortgage assets susceptible to severe stress, by 2018.
The test results were published at the same time as the Bank’s Financial Stability Report, which highlighted how weakness in the global economy could affect the outlook for stability in the UK.
It said the recent sharp fall in the oil price should support growth but also pose risks to stability.
The report also raised concerns about an increase in the risks from the UK housing market, saying this increase had not so far happened but that household debt levels remained high, supporting the Bank’s decision six months ago to take measures to prevent an overheating housing market.
It also said changes were needed in the way banks were run following a series of scandals - which was most recently highlighted by the foreign exchange-rigging affair.
The report said: “Recent misconduct and other operational failings have highlighted that rebuilding confidence in the banking system requires more than financial resilience.
“That, and changes to the banks’ business models in response to commercial and regulatory developments, make it important for banks to continue to enhance the effectiveness of their governance arrangements.”