Banks told to predict effects of a 39 percent crash in house prices

Banks in the UK have been ordered by financial regulators to assess how they would cope in the event of house prices crashing by 40 per cent.

The instruction to include a housing slump scenario in their stress-testing models comes after the Financial Services Authority found that some banks were failing to include gloomy enough assumptions in their modelling.

The FSA said yesterday that an “appropriate” benchmark was to assume property prices fell by 40 per cent and that 35 per cent of mortgages in default ended with homes being re-possessed. It stressed that this was not a forecast but a “severe but plausible scenario” and one that banks should examine when deciding how robust their balance sheets were.

In a speech to the British Bankers’ Association yesterday, Clive Briault, the FSA’s managing director for retail markets, remarked on banks’ differing views over the size and impact of a house market downturn, hence the need for reference points.

He also warned bankers to ensure that they have properly stress-tested their mortgage portfolios in the wake of decisions by some to lend people greater multiples of their incomes.

In a letter to bank chief executives last month the FSA accused some of failing to consider scenarios in which they might be forced into losses, dividend cuts or capital shortfalls.

“We were struck by how mild the firm-wide stress events were at some of the firms we visited,” wrote the FSA’s director of major retail groups, David Strachan.

A few banks were “weak in all respects” in stress-testing.

House prices fell about 15 per cent nationwide in 1989-1992, and in parts of East Anglia by 40 per cent, leading to repossessions, write-downs and bank losses.

Banks are obliged to stress-test hypothetical adverse movements in asset prices, interest rates and exchange rates to ensure that they have a sufficient capital cushion. But stress-testing is only as robust as the assumptions made.

The FSA move came as UK house prices grew at their fastest for four years, according to new figures from RICS.