By Robert Miller (Filed: 26/01/2006)
http://www.telegraph.co.uk/money/main.jhtml?xml=/money/2006/01/26/cnfsa26.xml&menuId $2&sSheet=/money/2006/01/26/ixcitytop.html The City's top watchdog warned banks, building societies and finance houses yesterday they could suffer severe damage to their reputations if the current turn in the lending cycle reveals "they have given credit to large numbers of consumers who are unable to afford their debt repayments".
In its Financial Risk Outlook 2006 the Financial Services Authority said: "Even in the current benign economic environment we are seeing signs of growing distress among consumers, including more insolvencies, more late payments on credit cards and a rise in mortgage repossession orders."
The FSA said: "Our research shows that many consumers with significant borrowing commitments are currently struggling to keep up, with repayments."
The watchdog also expressed concern that rising household debt problems, coupled with the current economic slowdown, meant consumers were taking financial decisions "with inadequate understanding of the potential risks."
In the wake of misselling scandals, such as those involving personal pensions, endowment mortgages and split capital investment trusts, the FSA noted that many people "have become increasingly disengaged from the market".
It also said some regulated firms were failing to make their product literature and sales processes "sufficiently transparent. There remains concern this could lead to unsuitable products being sold to consumers who, in reality, have a low-risk appetite and low risk tolerance."
The FSA also warned large banks and trading houses that they need to do more "stress" tests on their portfolios of sophisticated and complex investment instruments, such as credit risk derivatives, to be able to cope with a sudden shock to the world's financial systems.
These, it said could take a variety of forms including "natural disasters (possibly driven by climate change), global pandemic, political instability, in a major economy, a large terrorist attack, or a major corporate bankruptcy, Market participants might find it difficult to manage their positions in certain instruments and could struggle to sell large quantities."
In one the strongest worded passages of the 100-page risk outlook the FSA said the illiquid nature of some of these complex investments "may increase the risks of conflicts of interest, or even fraud, to the detriment of the investor and of market confidence more generally.
"A significant proportion of revenue, of both traditional and alternative fund managers, comes from management and performance fees. Since these fees are a function of asset valuations there may be incentives to overvalue assets." Incidents of "false and fraudulent" valuations are increasing, the FSA said.
Debt helpline swamped by anxious callers