'Deeper' recession will lead to financial crime wave

The recession may be "deeper and more prolonged than expected", with continuing pressure on a weakened banking sector, the housing market and an upsurge in fraud to look forward to over the coming months, according to the latest review of conditions by the Financial Services Authority.

The warning comes after the managing director of the International Monetary Fund, Dominique Strauss-Kahn, said the world's advanced economies were "already in depression", and that the IMF could slash its global growth forecasts still further: the "worst cannot be ruled out".

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The FSA's latest Financial Risk Outlook agrees, arguing that the global financial system has "suffered its greatest crisis in more than 70 years" and that the collapse of Lehman Brothers in September prompted a "sudden breakdown of confidence", an implicit criticism of the US authorities for failing to rescue the US investment bank.

Lord Turner, the FSA's chairman, also attacked the US for preventing the International Monetary Fund from scrutinising the US financial system. "There has never been an IMF report on the US financial system because the US didn't want one," Lord Turner said. The IMF needs to be able to publish analysis of what is happening in markets "without feeling that they are under pressure to water it down from major economic powers", he said.

The FSA said of the economy: "The risks are weighted to the downside and, while the effects of fiscal stimulus and monetary easing remain unclear, the recession may be deeper and more prolonged than expected." The possibility of the decline in bank lending leading to a vicious cycle of economic decline was explicitly highlighted by the watchdog: "These self-reinforcing cycles exist in any economic downturn, but the crucial danger in the current crisis is that weakness in the banking system could stimulate and reinforce them." The £37bn recapitalisation of the banks may not be enough to save them, the FSA hinted.

The existence of a large buy-to-let sector could, the FSA warns, lead to a "self-fulfilling" fall in property values, as "investment properties are more sensitive to expectations of property prices and rental yields than residential purchases. Weaknesses in the buy-to-let market, in turn, may have tended to reinforce the weaknesses in the wider residential market, and expectations of future house price falls could in turn become self-fulfilling".

It adds that mortgage lenders could be in a hurry to repossess properties before their value slumps still further, and that "appropriate firm practice in relation to possessions – recently reinforced by the Government's code of conduct – is therefore not only important from the perspective of treating customers fairly , but can have a macroeconomic effect".

The Royal Institution of Chartered Surveyors confirmed that activity in the property world remains depressed. The average number of transactions per estate agency, at just under 10 during January, is the lowest figure since the Rics survey began in 1978. The balance of surveyors reporting house price falls increased slightly in December. However, new buyer enquiries, apparently from eager bargain-hunters, are up a little.

However, the most novel aspect of the FSA's report is its stark view of a financial crime wave about to engulf the nation, affecting both customers and firms. "The recession may increase the motivation for employees and customers to commit fraud against banks in an attempt to maintain their existing lifestyles, replace lost funds, or meet increasingly challenging revenue and sales targets... Criminals appear to be changing the way in which they commit financial crime, indicating an increasing sophistication as they require more complete data to commit such crimes. Criminals may now target employees disgruntled by the threat of redundancy, poor pay rises and increasing financial pressures," the FSA report notes.

The FSA echoes views recently voiced by the Prime Minister and others about the City bonus culture and the "widespread concern that remuneration polices may have been a contributory factor to the market crisis... Remuneration policies were running counter to sound risk management".

The banks, says the FSA, now need to "focus their strategy on medium-term survival rather than on short-term profitability". The FSA sees little chance that banks and mortgage brokers will learn their lessons and that "there is a risk that when the mortgage market recovers, problems of consumers being sold unaffordable and unsuitable mortgages will re-emerge".

Lord Turner said that the regulators had failed to anticipate the banking sector's problems. "One of the things we have to get right is better macro-prudential analysis which identifies when there has been big build-ups of risk." The FSA favours "macroprudential tools", using capital ratios to make banks lend less in credit booms, but more in recessions – something the Bank of England seems keen on.

Lord Turner will publish his review of financial regulation next month and promised that it would look at whether bonuses "tend to produce an unnecessarily short-term focus".