Commercial insurance article archive
FSA alarmed about stresses in banking and finance
A gloomy future appears to be in store for the financial sector according to reports from industry watchdog, the Financial Services Authority (FSA).
In its annual Financial Risk Outlook the FSA predicted a bleak future for the banking industry highlighting a range of difficult outcomes of the credit crunch, including a strain on banks' business models and risks to consumers with debt, reports the Financial Times.
Market turmoil may see consumers' lose faith in the financial system, the report said.
"As bad as things are, they could get worse," Thomas Huertas, director of banking supervision at the FSA, said in a speech at a separate banking conference, the news provider reports.
The watchdog has scrapped plans to cut 300 jobs - keeping 90 employees to increase focus on small firms and other areas and is reviewing its supervisory practices, reports the Financial Times.
Commenting on the FSA's activities, Ian Mason of Barlow Lyde and Gilbert said: "It's very much aimed at 'we don't want another Northern Rock nor have our own SocGen'. But it's going to be quite a stretch to achieve everything."
The FSA's chief executive Hector Sants commented: "Times are a lot more uncertain than they have been and it is very difficult to predict market conditions or precise circumstances and consequence.
"When we look back at the end of this year, I expect it will probably end up that we've followed a slightly different plan from today's document."
The watchdog has encouraged banks to "stress-test" their business models - particularly in the aftermath of the Societe Generale scandal.
"You can never say never. But the firms are taking this very seriously and reviewing their processes," said Lyndon Nelson, head of risk at the FSA.
"Given the criticism of the FSA over the extent to which it ensure that Northern Rock's stress-testing was adequate, regulated firms can expect lengthy and detailed discussions as to the robustness of their stress-testing over the coming years," Carlos Conceicao, a partner at Clifford Chance told the news provider.
The FSA announced earlier this month in its 2008 business plan that it would increase spending by seven per cent to £323 million in a bid to increase supervision within the financial sector.
The increases will be mostly met by contributions from individual companies.
Following criticism of the FSA for failing to restrict the activities of Northern Rock, Hector Sants said: "The outcome of the follow-up initiatives arising from the various reviews of Northern Rock is likely to cause us to reassess our priorities for the year".
The Daily Telegraph reports that a "lessons learned" review of the authority's approach has been commissioned, he said.
"It will be a challenge for firms to ensure they are adequately equipped to deal with uncertain market conditions while maintaining sufficient focus on other important business-as-usual processes and regulatory priorities," the FSA said.
The credit crunch has also revealed flaws in the Basel II framework. Adopted by most banks in full at the beginning of the year it was seen as an opportunity for banks to improve the efficiency of their balance sheets.
According to the Financial Times, cracks have appeared in the regulatory framework particularly during the Northern Rock debacle.
Designed to improve management of capital by banks by encouraging them to build models to track their lending, Basel II does not focus on banks' liquidity - highlighted in the Northern Rock crisis - and does not acknowledge the commitments banks make to protect their reputations, argues the Financial Times.
Banks are not the only casualties of the uncertain outlook. Consumers could also be badly afflicted by the economic downturn.
According to the FSA, one-third of new mortgages issued in the past two years have a series of high-risk factors including high ratios of the loan relative to borrowers' income and to the value of the property.
The watchdog has said it is "concerned about consumers' ability to understand increasingly complex products" which could lead to investment in "inappropriate products".
The European commission is assessing whether the Ucits III investment funds regime should be widened to include products such as funds of hedge funds and open-ended real estate funds, reports the Financial Times.
In its 2008 Financial Risk Outlook, the FSA warned: "it is questionable whether all asset managers have the appropriate systems and skills to manage and control the wide range of new products available to a consistently high standard.
"The rapid pace of change has resulted in managers expanding their offerings from traditional to alternative asset management, from developed to emerging markets and from long/short investment management styles. These new areas involve the use of skills that are in short supply."
Asset managers continue to face challenges in administration, operations and IT system which could lead to incorrect trades, mandate breaches or valuation errors, the FSA reports.
Clark Cheng, head of research at the alternative investment group at HSBC Private Bank, is concerned about whether all asset managers launching these funds have necessary skills and systems in place, the Financial Times reports.
He told the news provider: "The FSA is right to raise this. The skill of shorting securities is a key to the success of a 130/30 fund manager yet few practitioners can provide evidence of their proficiency."
"As a long position's price declines it becomes a smaller position of the portfolio while losses are capped at the initial investment. When a short position turns against its seller the potential losses are unlimited."
Simon Fraser, president of institutional business at Fidelity International, told the news provider that shorting stocks was "more difficult than some fund managers might think".
Last year Tony Solway, head of BNP Paribas Securities Services UK, informed the Financial Times, with regards to one fund: "Three years ago it wasn't using any derivatives, now it has 3,500 open positions. Nobody understood the impact of Ucits III."
02 Mar 2008