FSA sets out its nightmare double-dip slump scenario

By ROB DAVIES FOR THE DAILY MAIL
Updated: 17:42 EST, 10 March 2010

Banks must be prepared for a double-dip recession and record unemployment, the country's financial watchdog has warned, in a sign that Britain may not yet be past the worst of the financial crisis.

The Financial Services Authority revised its worst-case parameters for the stress-testing of banks to include a GDP decline of a further 2.4 percentage points by the end of 2011 - or an 8.1 per cent peak to trough fall - with unemployment rising to an all-time high of 13.3 per cent and house prices falling 36 per cent from 2010 to the end of 2014.

The nightmare scenario - which envisages factors that might prevent banks from keeping core tier one capital ratios above the required 4 per cent - is even worse than the regulator's gloomiest assessment at the depths of the recession last March.

Stress test: City watchdog the FSA is warning that banks must prepare for record unemployment

FSA chairman Lord Turner said he expected Britain to undergo a gradual V-shaped recovery, but added that stringent tests would be 'a crucial part of our approach' in ensuring banks were also ready for a double-dip recession.

Turner also warned that imposing stricter liquidity requirements too quickly could damage the economy and should be carefully coordinated with the Bank of England's withdrawal of the £185bn Special Liquidity Scheme, which is slated to be phased out from next year.

'You can't simply wean yourself off it without a shock to the economy,' he said.

'If you go from A to B too quickly, it risks making the downswing worse.'

The FSA is now working with banks to identify a sustainable funding strategy, including holding higher levels of retail deposits and enforcing longer-term maturities on wholesale borrowing.

Turner said banks were likely to reveal more bad debts, but said there were unlikely to be any 'nasty surprises’ not already being factored-into the plans of lenders and the regulator itself.

The FSA chief played down suggestions that speculators betting on Greece defaulting on its debt was playing a key role in the country's economic woes, saying that such an opinion was 'over-simplistic'.

There is a case for banning speculation designed to drive down sovereign debt prices he said, but this should not come at the risk of preventing legitimate hedges, he added.

Turner also signalled the regulator would toughen up its approach to the mis-selling of financial products.

FSA chief executive Hector Sants will give more detail in a speech on Friday, but Turner also said the watchdog was looking at banning self-certified mortgages.