Britain's financial regulator said the tests it uses to gauge banks' capital strength assume house prices will halve and GDP shrink 6 per cent in the current recession, making it the country's worst for more than 60 years.
Publishing details of its "stress tests" for the first time, the Financial Services Authority said they assumed unemployment peaking at 12 per cent, and no growth in the economy until 2011.
The tests also factor in a 60 per cent peak-to-trough slump in commercial property values, outstripping the assumed 50 percent drop in residential prices.
“The current stress scenario models a recession more severe and more prolonged than those which the UK suffered in the 1980s and 1990s and therefore more severe than any since the Second World War," the FSA said in a statement today.
Credit Suisse banks analyst Jonathan Pierce said the FSA's assumptions were less gloomy than predicted. "On balance, this might be seen as slightly less severe than expected,” he wrote in a note.
“In fairness, the stress test was developed four months ago when economic forecasts weren't quite so bad and a 6 per cent GDP move and 12 per cent unemployment was likely deemed a low-probability event.”
The FSA said it would not disclose how individual banks had fared in the stress test.
But it confirmed that the test had been applied to Royal Bank of Scotland and Lloyds Banking Group as part of their application to join the government's asset protection scheme, under which the state insures banks against losses on risky debt-backed assets.
In March, Barclays said it had undergone a “detailed” stress test which had shown that it met the FSA's capital requirements. No other banks have commented on whether they have been tested or on the outcome of any test.
The tests are designed to determine whether banks' core Tier 1 capital ratios are at risk of falling below the FSA's minimum threshold of 4 per cent in the event of a worse-than-expected economic deterioration.
The FSA's tests are based on a more pessimistic scenario than that assumed by regulators in the US.
There, banks' capital strength was tested against an economic contraction of 3.3 per cent and a 22 per cent fall in house prices in 2009 alone, with unemployment peaking at 10.3 per cent, according to the Federal Reserve website.
The FSA's stress-test scenario compares with an official British government forecast for economic growth of 1.25 per cent next year following a 3.5 per cent contraction in 2009.
According to the closely watched Halifax house price survey, residential home values were down 22 per cent in April from their August 2007 peak, against the FSA's assumption of a 50 per cent fall.
Reuters