OREANDA-NEWS. The Bank of England's (BoE) 2015 stress test for UK banks includes a specific China stress that looks tough even against the recent economic weakness and currency depreciation, and this will add credibility to the results, says Fitch Ratings.

The BoE's 2015 baseline GDP growth figure for the China scenario, at 6%, is in line with Fitch's 6.8% forecast. But a sharp slowdown in growth to 1.7% in 4Q15, the basis of the stressed scenario, still looks highly unlikely. This is good because the purpose of the stress framework is to assess the sector's capital adequacy when faced with a set of adverse, yet plausible, scenarios. Any stress-testing exercise will only be credible if the underlying scenario design is sufficiently harsh to shock fundamentals. The BoE envisages real growth remaining positive for China, steadily returning to an annual 6% by 2019.

The BoE China stresses also include a 10% depreciation of the yuan against the US dollar. In light of recent changes to exchange-rate policy announced by the People's Bank of China, and the subsequent depreciation of the yuan, the BoE's stress now appears soft. Since 11 August, the daily yuan/dollar exchange rate band of plus/minus 2% will fluctuate with reference to the previous day's spot market closing price, making the exchange rate more market-determined. Although the immediate uptick in yuan/dollar volatility may prove short-lived, there is scope for greater depreciation under the refined fixing mechanism.

Chinese residential property prices are also stressed in the test, with a 35% decline by end-2016 from mid-2014, while commercial real estate falls are even steeper. House price depreciation in Hong Kong, whose economy is closely correlated to China's downturn given close trade and financial links, is set even higher at 38%. We view these scenarios as robust, considering both historic volatility and data provided by the National Statistics Institute of China, which shows house prices across 36 major Chinese cities still registering a modest 3% rise over the 12 months to end-June.

The China stress scenarios are most relevant to HSBC and Standard Chartered, both of which have strong links to Asia and considerable risk assets in both China and Hong Kong.

HSBC's June investor update and comments with its interim results in August highlighted the drive to capture growth opportunities in China's Pearl River Delta and in South East Asia. Fitch expects the group's asset quality to hold up well although we expect moderate loan deterioration from the slowing Chinese economy. HSBC's ratings are on Stable Outlook, which captures our expectation that the group will maintain a conservative appetite for risk and low overall risk profile.

Fitch's view is that Standard Chartered is concentrated on China, with USD66bn net exposure at end-2014 equivalent to around 1.6X Fitch core capital. Fitch maintains a Negative Outlook on Standard Chartered's ratings because we believe that the group's capital profile could become misaligned with our expectations for capital relative to the risks attached to its operations in higher-risk markets, including mainland China.

The BoE stresses, which explore both domestic and global risks, envisage a fall in economic output across a number of regions including the euro area, emerging markets and the UK. They also factor in weak commodity prices and the oil price falling to USD38/barrel, and low inflation. The results are due to be published in 4Q15.