FSA tries to break the banks with 'worst-case' stress tests

BRITAIN'S financial regulator is stress-testing banks to withstand an economic meltdown that involves a halving of house prices and a 6 per cent slide in GDP, it emerged yesterday.

Publishing details of the stress tests on the likes of Royal Bank of Scotland and Lloyds Banking Group for the first time, the Financial Services Authority sketched a gloomy economic picture.

Among the other tough scenarios being contemplated are the UK remaining in recession throughout 2010 and unemployment hitting 12 per cent.

The FSA is also testing banks' capital strength against a 50 per cent peak-to-trough fall in house prices and a 60 per cent slump in commercial property prices.

Yesterday, the regulator stressed that the scenarios were not forecasts of what will happen but were "deliberately designed to be severe".

It said: "The current stress scenario models a recession more severe and more prolonged than those which the UK suffered in the 1980s and 1990s and therefore more severe than any other since the Second World War."

However, the FSA would not disclose how individual banks had fared – in stark contrast to the US, where the results of similar tests were recently outlined.

The FSA confirmed that its tests had been applied to RBS and Lloyds Banking Group as part of their application to join the government's asset protection scheme, under which the state insures banks against losses on risky debt-backed assets.

RBS wants to insure £325bn of assets and Lloyds some £260bn.

In March, Barclays said it had undergone a "detailed" stress test which had shown that it met the FSA's requirements. RBS and Lloyds declined to comment.

The gloomy scenario was also used in the regulator's analysis of Dunfermline Building Society which identified future potential threats to the society's capital adequacy, the FSA said.

Banks were the worst-performing shares yesterday, with Barclays, HSBC, Standard Chartered, Lloyds Banking Group and Royal Bank of Scotland down between 0.8 per cent and 4.6 per cent.

City analysts said some of the regulator's economic assumptions were less pessimistic than expected. Credit Suisse banks analyst Jonathan Pierce said in a note yesterday: "On balance, this might be seen as slightly less severe than expected.

"In fairness, the stress test was developed four months ago when economic forecasts weren't quite so bad and a 6 per cent GDP move and 12 per cent unemployment was likely deemed low-probability."

Simon Willis, analyst at NCB Stockbrokers, told The Scotsman: "The FSA's scenario is a tough one and I'm sure it is worse than most people's forecast economic cases. But I would not call it Draconian."

Some in the City were disappointed that more detail of the individual health of banks stress-tested was not given.

Keith Bowman at broker Hargreaves Lansdown said: "The City always likes to delve for detail. But the regulator sees a large part of its job as maintaining stability and so that probably guided it."