THE UK banking system is facing another crisis, but on a much bigger scale than the financial collapse in 2007-8, according to one of the world’s leading think tanks, the Adam Smith Institute.

In a report published today, it ridicules the Bank of England’s stress tests – which it describes as “worse than useless” – that disguise the chronic weakness of the UK’s banking system.

The report – No Stress II: the flaws in the Bank of England’s stress testing programme – suggests the reality is that the system is still in poor financial shape, a fact the tests disguise.

It challenges the stress tests carried out by the Bank of England to assess the financial resilience of UK banks, and contradicts their claim that major UK banks could withstand another big shock.

The report says every single UK bank would fail the more rigorous stress tests undertaken by the US Federal Reserve; says the UK is sailing blindly into a second global financial crisis; and calls for stress testing to be abolished with decision-makers made personally liable for risks.

Report author Kevin Dowd, professor of finance and economics at Durham University, said: “The purpose of the stress-testing programme should be to highlight the vulnerability of our banking system and the need to rebuild it.

“Instead, it has achieved the exact opposite, portraying a weak banking system as strong. This is like having a ship radar system that cannot detect an iceberg in plain view.”

The report’s release comes as the free market think thank says Europe is facing a renewed banking crisis, with major problems in Italy and mounting concerns about Deutsche Bank, the biggest bank in Europe, which was described by the International Monetary Fund (IMF) as the most systemically dangerous bank in the world.

According to the report, the UK banking system is not much stronger. Current Bank of England stress tests are like a ridiculously easy exam with a ludicrously low pass standard.

If you increase the pass standard to something reasonable, like that used by the Federal Reserve, then every single major bank in the UK would fail.

Dowd’s report highlights 13 fatal flaws in the stress tests, most of which cannot be fixed.

It argues that stress testing methodology is completely compromised: it purports to be able to identify bank vulnerabilities, but there has never been a single case where stress tests were able to identify vulnerabilities in advance and fix them accordingly.

This was seen in Iceland, Ireland, Cyprus and Greece – entire national banking systems signed off as sound by stress tests, only to collapse shortly afterwards.

Dowd added: “As the EU banking system goes into a renewed crisis, the UK banking system is in no fit state to withstand the storm. Once contagion spreads from Italy to Germany and then to the UK, we will have a new banking crisis but on a much grander scale than ’07-08.

“The Bank of England is asleep at the wheel again, and we will be back to beleaguered ‘banksters’ begging for bailouts – and the taxpayer will be ripped off yet again, but bigger this time.”