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28th May 2009
FSA Reveals Stress Test Model
The Financial Services Authority has revealed it is stress testing banks’ capital against the impact of a 50% peak-to-trough fall in house prices.
The regulator has issued a statement this morning giving more detail about the current stress model it is applying to the UK banking system, following the recent publication of US bank stress tests.
The FSA says it won’t be following the US lead and says it has decided not to publish its results as the stress tests may change over time.
But it has revealed some details on the current model it is using to forecast which institutions are holding loans that may sour in the future.
The statement reads: “The stress tests used are not forecasts of what is likely to happen but deliberately designed to be severe.
“Their purpose is to consider whether an institution would be able to sustain adequate capital and liquidity under conditions which at the time the stress is conducted are considered unlikely to arise.
“Since the FSA’s use of stress tests has not been a one-off exercise but instead embedded in our regular supervisory processes the FSA will not, as a matter of practice, be publishing details of the stress test results.”
The regulator says it is currently testing to see if the capital banks are holding can withstand a longer and deeper recession than suffered by the UK in 1980s and 1990s, and as a result more severe than any recession since World War II.
The stress-tests are also factoring in a peak-to-trough fall in GDP of 6% with growth not returning until 2011.
The model is also testing the impact of unemployment rising to just over 12%, a 50% peak-to-trough fall in house prices and a 60% peak-to-trough fall in commercial property prices.
The FSA has already applied these stress tests to Royal Bank of Scotland and Lloyds Banking Group before their participation in the government’s Asset Protection Scheme.
These tests were also used to the Dunfermline’s capital adequacy prior to Nationwide acquiring some of the building society’s assets.
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