08 May 2008

FSA Sants warns building societies need more robust stress testing

The FSA warned building societies to do more on their stress testing assumptions to cope with extreme situations like the liquidity crunch. “Experience to date shows many of you generally have not modelled sufficiently extreme stress scenarios”, Sants said. 

The FSA warned building societies to do more on their stress testing assumptions to cope with extreme situations like the liquidity crunch. “Experience to date shows many of you generally have not modelled sufficiently extreme stress scenarios”, Sants said. 

 

“Most of the stress testing performed before last August was based on a firm-specific rating downgrade and it was assumed these would reopen quickly”, FSA Chief Executive Hector Sants said and underlined that building societies stress testing assumptions needed to be much more robust.

 

Touching on the appropriate level of liquidity, Mr Sants said that recent events have shown that the stock of liquidity held, in many cases, has proved less liquid than the regime envisaged. “We are looking to build in both a stock of assets that can be turned into cash if needed for a short term-retail outflow, and a longer term mismatch ladder that shows inflows against worst case outflows”, he said. “Whether or not we set hard quantitative limits is still under debate, not just in the UK but in Europe and across the world.”

 

Moving onto capital adequacy and credit, Mr Sants outlined three risk areas the FSA identified: excessive concentration in the buy to let market; continued acquisition of mortgage books, even when routine funding was becoming problematic; and poor understanding of the extra risk of major exposures to commercial borrowers. “We still find unacceptable practices during our visits to some firms”, he warned. “I must therefore emphasise again, it is the responsibility of the Board to test and challenge such proposals from management. A simple rule of thumb for boards is not to take on the risk of products they do not understand.”

 

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