The Worst-Case Scenario of the Recession from FSA

Financial regulators have revealed one of the possible worst-case scenarios of the downturn the UK and the rest of the world is going through at the moment. The scenario involves the unemployment rate rise by another 1.5 million in the UK and the average house price drop to as low as £93,000. The scenario’s creator was the Financial Services Authority (FSA). FSA regulates the whole financial services industry in the UK and it is well aware of banks’ financial strength. FSA worked out fictional scenarios and applied them to banks in order to see if their balance sheets handle a prolonged, deep downturn. The scenario also predicted that the recession would continue for another year and a half, then would reach its trough and only after that the economy would settle down to a recovery course. However, according to FSA prognosis, this scenario is not what is likely to happen. This was a kind of stress test for banks. The FSA’s intention was just to prove banks’ solvency and see if the UK financial institutions were ready to cope with the worst economic recession since the World War II. The major assumptions in the stress test were the following. The economy shrinks by 6% from its peak. The growth comes back in 2011 and the trend growth starts in 2012. As for the unemployment rate, it was assumed to rise to 12%, which would make up 3.7 million people of the workforce. This figure implies that another 1.5 million people would lose their jobs. This presumed unemployment rate would become the highest rate ever, even as compared to the amount of unemployed people during the downturn of the early 1980s. The most shocking assumption was the house price fall. The FSA forecast house prices halving from their peak of £186,000 in October 2007 to only £93,000. According to the National Building Society, the official statistics shows that house prices have fallen by 19% from their highest point so far. Basing on the results of the stress test, FSA concluded that all banks and building societies would fight out even such a strong economic storm. The test showed that their capital cushions never fell below 4% of assets. After Barclays had passed its stress test, it eliminated the necessity to raise fresh capital or participate in the Government’s Asset Protection Scheme (APS). This scheme is a secure protection for banks against enormous losses on hundreds of billions of pounds of investments and toxic loans. The Royal Bank of Scotland, as well as Lloyds Banking Group were subjected to stress testing as a condition of the banks’ participation in the APS. However, analysts claimed that the test parameters were not stern enough. The actually expected GDP fall makes up 4.5%, and the predicted unemployment rate equals to 10.5%. Analysts from Credit Suisse commented that these figures are not significantly better than the assumptions made by the FSA in the testing. But the house price scenario was acknowledged as a pretty extreme. The FSA also affirmed for the first time that it took into consideration the possibility that banks would raise fresh capital or make emergency asset sales in order to bolster balance sheet ratios. This is, presumably, the way Barclays passed its stress test. The first signs that the recession may be bottoming out and the APS have eased the tension concerned with banks’ solvency worries.