FSA Requests Additional Stress Testing

Britain officially emerged from its two-year recession in the final quarter of 2009, but a recent communiqué from the country’s main financial regulator, suggests that a return to recession is not out of the question. The Financial Services Authority (FSA) recently requested that financial institutions undergo another round of “stress tests” to ensure the nation’s major banking institutions can withstand a greater decline in growth than originally projected.

The idea of stress testing, is to determine the impact a given set of circumstances could have on the nation’s banks. Last spring, the banks were required to conduct a series of stress tests that assumed the economy would contract by 6.9 percent, with no appreciable growth until 2011. A return to trending growth however, was not envisioned until late 2012. Under these dire conditions, unemployment was projected to jump to a full 12 percent of the workforce, an increase of more than 1.5 million people.

The stress test the FSA wants to use now, is based on the assumption that Britain’s Gross Domestic Product (GDP) will fall even more than last year’s projection – 8.1 percent compared to 6.9 percent. The employment outlook for the new round of testing has also been downgraded to 13.3 percent unemployment, representing 4.2 million unemployed. In truth, the conditions for this round of stress testing are more closely matched to those of the Great Depression of the 1930s than last year’s recession.

This could simply be the case of the FSA modeling and testing for the absolute worst-case scenario, and if that is the case, then kudos for thoroughness. On the other hand, if the FSA believes that it is even remotely possible for this level of carnage to be in play, then it may be time to think about limiting GBP exposure.

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