FSA reconsiders worst-case scenario stress test for banking sector

Just a few months ago the Financial Services Authority (FSA) had a plan in place to test the strength of UK banks and UK financial institutions in the event of a nightmare scenario. The FSA had assumed a worst-case scenario of a peak to trough reduction in GDP of 6.9% as a means of testing banks in a situation that was unlikely to arise. However, the recent recession brought a peak to trough reduction in GDP of 6.2% and the FSA has now announced plans to reconsider its "worst case scenario" situation for the future.

There is talk of using a potential 8.1% peak to trough fall in GDP as a benchmark for the future against which the strength of the UK financial sector as a whole and the individual components would be tested. The problem for the financial sector would be the need to create a buffer between required funding and a worst-case scenario funding situation. This will take away much-needed liquidity from the banks at some stage although thankfully the FSA is unlikely to introduce these new liquidity levels until the recession is well and truly over and liquidity and funding levels are back to "normal" levels.