Bank of England Looks to Improve Its Stress Test Capabilities

With little fanfare, Bank of England announced that it is improving its ability to conduct stress tests.

British market watchdogs will rely more heavily on their own stress testing of the nation's banks as part of the U.K. coalition government's overhaul of the country's financial regulators, the head of the Financial Services Authority said.

Regulators will carry out their own investigations rather than rely on banks or their auditors, and are stepping up capacity to be able to make better judgments in-house, added Hector Sants, the FSA's chief executive. He will head a new super-regulator called the Prudential Regulation Authority in 2012.

"Regulators should not rely solely on the judgments made by firms or their auditors," he told a Thomson Reuters conference Monday. "We have to have the capability in-house to make these judgments."

As part of a shake-up of financial regulation proposed by the U.K.'s coalition government, the FSA will be dismantled by 2012. Its responsibilities will be divided between the Prudential Regulation Authority, which will be part of the Bank of England, and the new Consumer Protection and Markets Authority.

Mr. Sants said the authority would make sure banks are sound via "thorough business model and market analysis, close engagement with auditors, and, where necessary, it will conduct its own in-depth stress testing to ensure its judgments are not reliant on firms' own capabilities." The tests will help ensure the stability of the U.K. economy, he added.

Stress tests carried out by the Committee of European Banking Supervisors earlier this year were widely criticized for not making sufficiently pessimistic assumptions about factors that could weaken banks' capital ratios. Only seven of 91 European banks failed.

Mr. Sants said the Prudential Regulation Authority would use about 200 recently hired specialists to carry out the tests, without elaborating. The FSA has historically relied on banks to carry out their own stress testing.

One of the reasons that the authorities relied on the banks to carry out their own stress testing is that the banks have access to the asset level detail that is necessary for conducting the stress tests.

Is the Prudential Regulation Authority going to have access to the asset level detail?  Is the Prudential Regulation Authority going to share this asset level detail with credit and equity market participants so they can do their own stress tests to confirm the findings of the Prudential Regulation Authority?