The Bank of England is preparing to order eight of the UK's biggest banks and building societies to ensure they are strong enough to withstand sharp drops in house prices and sudden rises in interest rates.
Before the formal publication of the tests, Sky News said banks would be required to show they could survive a 35% fall in house prices and interest rates jumping to 5%, after five years at a record low of 0.5%. The conditions that banks must be able to withstand are to be outlined by the Bank of England on Tuesday.
The so-called stress tests are to be conducted by the Bank's Prudential Regulation Authority. Seven banks – the bailed-out Royal Bank of Scotland and Lloyds Banking Group, as well as Barclays, HSBC, Standard Chartered, Co-operative and the UK arm of Spain's Santander – are to be subjected to the Bank of England's tests, along with Nationwide building society.
The tests are being announced as the EU's banking regulator prepares to outline details of its co-ordinated programme to make the financial system across the EU resilient enough to withstand market turmoil, with a sample of about 124 banks to be included. Only four UK banks – Barclays, HSBC, Lloyds and RBS – will be part of the EU's examination.
The scenarios being drawn up will not be forecasts by the Bank but are intended to demonstrate that the institutions are being subjected to severe tests.
"The government created the new regulatory system in order to build a resilient economy and avoid repeating the mistakes of the past. Building strong and resilient banks is a core part of our long-term economic plan," the Treasury said.
The tests take place at a time when much focus is being placed on rising house prices amid warnings of a London "superbubble", with price rises rippling outwards across the country.
In February, house prices in the capital soared almost 18% on a year earlier to an average of £458,000, according to the most recent figures from the Office for National Statistics. It also reports house price growth picking up steam across most parts of the UK, adding to fears that a bubble could spread.
That has chimed with anecdotal evidence from estate agents and surveyors in recent months that the surge in activity and prices has started to spread beyond the south-east, buoyed by growing confidence in the economy and government initiatives to support buyers with small deposits. For the UK as a whole, house prices were up 9.1% in February, the fastest annual inflation for more than three and a half years.
As of the weekend, new tests are being conducted on would-be borrowers to ensure they have enough cash to repay mortgages at current rates, as well as at a higher rate of 7%.
Banking stress tests have been in focus since the 2008 crisis when banks across Europe were found to have run short of resources to withstand losses on loans and changes in the way they could raise finance on the money markets.
But early tests were discovered to be too lenient after Ireland's banks, for instance, were given a clean bill of health just before they ran out of capital.
The tests are expected to cover three years to 2016, and the European Banking Authority, which is overseeing the tests, is allowing local regulators – such as the Bank of England – to make their tests tougher.
Last year the Bank of England announced its intention was to conduct annual stress tests of all the major banks and subsidiaries after a consultation with the industry.
A year ago, policymakers at the Bank of England warned banks needed to find £25bn of extra capital to cover bad loans and mis-selling claims.
The US already conducts such tests and on Monday one of the country's biggest banks – Bank of America – was forced to retake its tests with the Federal Reserve after uncovering a banking error that dated back to 2007.
As a result, Bank of America, which bought Merrill Lynch as Lehman Brothers was collapsing in 2008, has been forced to suspend its plans to increase its dividend payout to shareholders.
