Tough tests for struggling banks

FSA has published details of the gloomy scenarios used to assess the vulnerability of banks

The health of UK banks is being tested against their ability to withstand the worst recession since the Second World War, the City watchdog has said.

The Financial Services Authority (FSA) has published details of the gloomy scenarios used to assess the vulnerability of banks' loan books and capital strength.

It is currently testing against a fall in overall GDP of more than 6% - with the UK remaining in recession until 2011 and unemployment hitting 12% - as well as a 50% peak-to-trough fall in house prices and a 60% fall in commercial property prices.

The FSA stresses that the scenarios are not forecasts of what will happen, but are "deliberately designed to be severe".

The tests were used on banks such as Royal Bank of Scotland and Lloyds Banking Group applying to dump "toxic" assets in the Government's taxpayer-backed insurance scheme, and to assess the health of the Dunfermline building society, which collapsed in March.

The watchdog said it will not publish the results because the tests are now a firm part of its day-to-day supervision of the sector.

"Given that the application of the tests has and will continue to evolve, the precise parameters used have changed and will change over time," it said.

In January, the FSA said banks should be able to maintain a core tier one ratio - a key measure of capital strength - of 4% even after the stress test.

Building societies applying to use the Government's credit guarantee scheme announced last October were also required to maintain a tier one ratio of 7% following the exercise.

The tests come as the FSA turns its focus from the alphabet soup of complex financial instruments which shook banks' balance sheets and caused the initial crisis, to the impact of recession on their loan books.