LLOY Lloyds Banking Group Plc

LONDON—Britain's largest banks could be forced to cut dividends as the Bank of England steps up pressure on them to hold more capital.

Analysts say U.K. regulators are making renewed efforts to get banks to hold more capital through increasingly stringent stress tests, even as the results of the most recent exam, due Tuesday, are expected to show a perfect pass rate.

The latest test studied how seven major banks—HSBC Holdings PLC, Barclays PLC, Lloyds Banking Group PLC, Standard Chartered PLC, Royal Bank of Scotland Group PLC, Santander UK and Nationwide Building Society—would fare in what have turned out to be real life scenarios of an emerging markets downturn and low oil price.

The banks should all be strong enough to pass, but analysts say the focus now is on the Bank of England's previously announced plans to make the tests even harder from next year. Banks that don't pass stress tests can be forced to raise additional capital or postpone paying shareholder dividends.

"We don't expect outright capital deficits on Tuesday," said Peter Richardson, a banking analyst at Berenberg. "What we do see is a growing headwind of tougher tests and higher hurdle rates to pass them. These will continue to erode expectations of dividends," he said.

Even before the stress tests, some banks have been revising their dividend plans. Standard Chartered canceled paying a year-end dividend and Barclays reversed plans to raise its payout. In both cases, the moves marked an effort by the banks to conserve capital as they undergo major restructurings. British banks, while widely seen as healthier than many of their continental European rivals, are still struggling to reshape their businesses to fit a tougher economic and regulatory climate for banking.

From next year, the regulatory demands are set to get even tougher, as the Bank of England raises the level of minimum capital needed by the seven banks to pass its annual test. Each bank will have a unique number of how much is enough, reflecting Bank of England requirements and additional global buffers for the country's four systemically important banks—Barclays, HSBC, RBS and Standard Chartered.

The move ties in with a growing reliance on stress tests by the Bank of England and regulators in the U.S. and elsewhere to predict how their banking systems would cope in stressful conditions.

"Stress tests (are) increasingly the primary way banks are regulated" in Britain, analysts at Morgan Stanley wrote in a report Tuesday, calling the health checks "a gate on payouts". They said higher capital levels than banks' current targets "could be needed for major U.K. banks to give comfort that thresholds are not likely to be breached during future stress tests".

Stress tests have become a key tool for the BOE and other banking regulators to determine whether banks have enough capital to withstand shocks and prevent a repeat of the financial crisis of 2008. The British tests assess the capital strength of individual banks, as well as the overall stability of the country's financial system. Banks that don't pass the tests can be forced to raise additional capital or postpone paying shareholder dividends.

Banks also face the possibility on Tuesday of a new capital buffer on their domestic lending, with signs that the Bank of England's Financial Policy Committee may be poised to make its first use of a so-called countercyclical buffer.

Bank of England Governor Mark Carney told lawmakers this week that the central bank is concerned about how borrowing at low rates over an extended period has fueled Britain's property market and other lending, and that the extra buffer could help smooth out problems.

At the core of officials' concern is a pickup in credit growth. Overall lending to consumers rose at a 3% annual rate in September, and growth in unsecured borrowing has accelerated to an annual 8% rate, according to BOE data.

While still well below the 10% annual growth in overall consumer lending that prevailed in the years before financial crisis struck in 2008, economists say the central bank could act to prevent credit growth accelerating further

"They are warming up to do it," said Richard Barwell, a senior economist at BNP Paribas Investment Partners and a former BOE official.

Jason Douglas contributed to this article.

Write to Margot Patrick at margot.patrick@wsj.com

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(END) Dow Jones Newswires

November 27, 2015 09:15 ET (14:15 GMT)

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