The Financial Services Authority yesterday responded to criticism of the excessive secrecy surrounding the "stress tests" it has run on Britain's banks. It went part of the way to revealing the details of those exercises – but again drew back from revealing how individual institutions had performed. Only Barclays has so far volunteered the information.
The FSA said it had asked the banks what might happen to them under these conditions: a fall in GDP of 6 per cent and the economy remains in recession until 2011; unemployment rises to 12 per cent; house prices fall by 50 per cent from the peaks in 2007; and the value of commercial property similarly falling by 60 per cent.
The FSA stressed that these did not represent economic forecasts but are "deliberately designed to be severe". They added that the results of the tests would continue to be confidential: "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 authorities have moved from assessing the banks' exposure to toxic assets and are now stressing the more predictable effects of recession on writedowns and how that might trigger a further devaluation of those asset-backed securities in an "adverse feedback loop". The tests have been applied to those banks seeking state aid, such as the Lloyds and Royal Bank of Scotland groups, and to the Dunfermline Building Society, which collapsed in March.
The FSA say that over the past eight months it has "greatly increased the use of stress tests". After the failure of Northern Rock the regulator came under fire for not researching what damage a "worst case scenario" might inflict on weaker organisations.
In January, the FSA stated that the banks should be able to maintain a core tier one ratio – a key measure of capital strength – of 4 per cent even after the stress test; the ratio for building societies is set at 4 per cent.
Even if the banks pass the various regulatory hurdles on capital adequacy they remain under intense pressure from the markets to preserve capital and shrink loan books. While this might be a rational course for individual institutions, the effects on the wider economy are damaging.
Alan Greenspan, the former chairman of the US Federal Reserve, and Mervyn King, Governor of the Bank of England, have voiced concerns on the issue of capital adequacy. Mr King said earlier this month: "There is quite a big difference in practice between the levels of capital that banks need to be stabilised, in the sense that the creditors are reassured that the banks can continue as viable entities on the one hand... and the levels of capital that are required to persuade banks to exhibit normal levels of risk aversion. How big that gap is, is absolutely impossible to say, but it looks as if it could be quite big."
The FSA's decision to keep the results secret contrasts with that of the American regulators, who have recently published the results of stress tests on 19 major banks.
The watchdog is also taking part in a Europe-wide stress-testing exercise of banks overseen by the European Union's Committee of European Banking Supervisors (Cebs), which will be completed by September.