30 January 2008

FT: FSA warns of more credit crunch pain

The banking world is facing its most difficult time since the recession of the early 1990s, the financial regulator said on Tuesday, as it warned that the credit crunch would take its toll on consumers too.

In its annual Financial Risk Outlook, the Financial Services Authority listed a range of hazards thrown up by the credit crunch, including the strain on banks’ business models and the risk that a “significant minority” of consumers would face problems as a result of their over-indebtedness.

Although the regulator emphasised that its report was not a prediction, only an attempt to raise awareness of the biggest problems, it made for gloomy reading.

Thomas Huertas, director of banking supervision at the FSA, echoed its conclusions in a speech to a separate banking conference.

“As bad as things are, they could get worse,” he warned.

Although the interbank rate – the rate at which banks lend to each other – has fallen significantly from its peaks, implying improving sentiment, Mr Huertas said it was too early to be confident.

“The question is whether this is the all-clear or the eye of the storm. There are ample signs this is the eye,” he added.

The FSA on Tuesday emphasised its work in encouraging banks to “stress-test” their business models. In last year’s risk report, it warned that banks needed to test further their operations in extreme scenarios, but made no follow-up in its more concrete business plan, released shortly afterwards.

“Given the criticism of the FSA over the extent to which it ensured that Northern Rock’s stress-testing was adequate, regulated firms can expect lengthy and detailed discussions as to the robustness of their stress-testing over the coming year,” said Carlos Conceicao, a partner at Clifford Chance.

The regulator said it was talking with banks about their risk management controls following Société Générale’s problems – which it described as a “wake-up call” for the industry.

“You can never say never,” said Lyndon Nelson, head of risk at the FSA in response to questions about whether a similar rogue trade could occur in the UK. “But the firms are taking this very seriously and reviewing their processes.”

It was not just misery for the industry; the outlook for consumers was also dismal. The regulator has calculated that one-third of new mortgages written in the past two years have a series of high-risk factors such as high ratios of the loan relative to borrowers’ income and to the value of the property.

An estimated 1.4m short-term fixed-rate mortgages are due to mature in the next 12 months. The FSA said that if those were replaced by standard floating-rate loans, monthly payments would rise steeply, squeezing those struggling with other debts.

“The problem is we don’t know their other borrowings and that is usually what tips them over the edge,” said Mr Nelson.

By Jennifer Hughes and FT Reporters

© Financial Times