FSA publishes Financial Risk Outlook 2007

The UK Financial Services Authority (FSA) has called on firms to improve the stress testing of their businesses after its financial risk report highlighted the greater impact a shock could have were it to happen in the next 18 months.

The FSA's Financial Risk Outlook (FRO) 2007, published this week, is designed to raise awareness of the priority risks which the FSA believes it, along with providers and users of financial services, should consider.

While the FSA's overall outlook for the global economy continues to be benign, the FRO identifies an increasing risk that it will become more unsettled. Key factors include the increasing geopolitical risks, which escalate the probability of an ‘event risk’ materialising; increasingly complex financial markets and the combination of low volatility of asset prices, a low market pricing of risk and stronger correlations between the prices of different classes of asset.

These trends mean that the impact of a shock to the financial system would be much greater now than two or three years ago.

A recent FSA review on stress testing found that, while good work was being done, some firms could be underestimating the probability of severe events. Firms should not overestimate their ability to take action in an effective and timely manner.

Callum McCarthy, chairman of the FSA said: "While the central case is one of continued economic and financial stability, the various trends in place now mean that were something to go wrong it would have a much bigger impact than two or three years ago. This has implications for both providers and consumers of financial services.

"I would encourage all firms to consider the risks outlined in the FRO and to plan accordingly. Stress testing and scenario analysis enable firms to assess and mitigate the risks that face them. It is important that firms use this period of relative stability to identify risks that could arise in less benign times. Our work shows that many firms still need to do more to develop their stress testing and to use more challenging scenarios."

Also examined in the FRO is the likely impact that a human influenza pandemic could have on the financial system. Terrorism is also highlighted as an ongoing priority risk.

Read the report.

•Date: 1st February 2007 • Region: UK •Type: Article •Topic: Financial sector
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