Tuesday, January 29, 2008

UK FSA "Financial Risk Outlook"

(FT Alphaville) First impressions of the 70-page Financial Risk Outlook for the year from the Financial Services Authority:

  1. It is rather backward-looking.
  2. It is filled with a variety of transport-related images: London Bridge station, some (non-UK) traffic lights, an escalator, a taxi.
  3. It has some pretty charts in it.
But perhaps we should pay more attention.

Last January, the FSA urged firms to improve the stress testing of their businesses as the report highlighted that the impact of a financial shock would be much greater than two or three years previously. Northern Rock apparently did not pay heed.

Last year’s picture theme, by the by, was bridges and buildings: St Paul’s, Southwark Bridge etc. Is there a metaphor here? Then we were made of solid stuff, now we’re in a state of flux? But then the FSA’s picture gallery has also gone from moody black and white to colour, which doesn’t seem so appropriate.

Here are this year’s priority risks:

  1. Existing business models of some financial institutions are under strain as a result of adverse market conditions.
  2. Increased financial pressures may lead to financial firms shifting their efforts away from focusing on conduct-of business requirements and from maintaining and strengthening business-as-usual processes.
  3. Market participants and consumers may lose confidence in financial institutions and in the authorities’ ability to
    safeguard the financial system.
  4. A significant minority of consumers could experience financial problems because of their high levels of borrowing.
  5. Tighter economic conditions could increase the incidence or discovery of some types of financial crime or lead to
    firms’ resources being diverted away from tackling financial crime.
One to four strike us as rather uncontroversial, and already probably upon us. (The same could be said for the FSA’s three risks to its central economic scenario - further reduction in the availability of credit; falls in property prices and rising inflationary pressure.)The first priority risk concerns the demise of SIVs, conduits and the like and the squeeze on securitisation and ‘originate and distribute’ in the banking business. The second is the danger that businesses under the kosh focus more on survival and less on treating their customers fairly. The FSA also highlights the need to build events seen in the second half of 2007 into internal controls, rather than dismiss them as unpredictable or one-offs.

The third is partially self-flagellating: “the events in the second half of 2007 revealed a marked decline in investor and consumer confidence in the markets, in some major financial institutions, and in the Tripartite authorities’ ability to safeguard the financial system. This gives rise to a risk that should consumers lose confidence in some parts of the financial sector, in extreme circumstances they could disengage from those parts of the industry.”

Number four is rather a given: there are 1.4m short-term fixed rate mortgages due to mature in the next 12 months meaning rising repayments, and almost a third of new mortgages contracts between the second quarter of 2005 and the third quarter of 2007 were made to borrowers exhibiting at least one risk characteristic, such as a high loan-to value or loan-to-income ratio.

But five looks more interesting. The FSA is worried about all sorts here: market abuse; money laundering; fraud; terrorism; identity theft; ‘boiler room fraud.’

They’re also drawing our attention to “organised property fraud,” an area in which the regulator is seeing increasing activity and looks set to rise further without coordinated action.

This is new to us. And it merits a box on page 36 of the report - which we found somewhat unclear in its explanation. But this is mainly targeted at new-build and purpose-built flats. Criminals’ gain is anticipated to be “very significant” and average losses on purpose built flats are around £45,000 on the sale of the property.

More details eagerly awaited from the FSA press office.

In a newsletter last October, the FSA described this phenomenon as “organised fraud using a network of complicit individuals in a systematic criminal attack on the financial sector.”

Exciting stuff. Later, we learn that, “these networks are often organised by a ‘controlling mind’” - or MR BIG. And that:

Profits from the frauds are often used as ’seed money’ to fund other crimes, including those not necessarily associated with the original fraud. Examples include drug and people trafficking.

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