Stressing Sants

The FSA's Hector Sants has been getting a grilling at the Treasury select committee today. One of the more troubling features of this was Sants' revelation that FSA's stress tests did not include turmoil in the credit markets.

According to the Guardian:

"We did not perform to my satisfaction with the stress-testing scenarios," said Mr Sants. "There are lessons to be learned."

[If that really was Sants' grammar, he might consider a remedial English course as part of the lessons to be learnt.]

Mr Sants said that the FSA had performed its last full assessment of Northern Rock in 2006, and was not due to conduct another until 2009. He explained that while the bank had been identified as a "high-impact organisation", the regulator had concluded there was only a low risk of it getting into difficulty.

It would be easy to conclude that this is shocking dereliction on FSA's part, and certainly a 1998-style credit crisis and liquidity meltdown would be an obvious stress scenario. But was the assessment of Northern Rock as 'low risk' really so obviously wrong? Low risk doesn't mean no risk, and low PD firms can still default. Originate and distribute was a perfectly respectable business model until mid 2007, and even if the securitisation market dried up, FSA might have concluded that Northern Rock could have borrowed in the interbank market. The fact that they couldn't was difficult to foresee. I don't think FSA comes out of this smelling of roses, and certainly the UK regulatory system did not operate perfectly, but we should not fall into the assumption that just because a bank had to access the lender of last resort FSA necessarily did something wrong. It might have done, but so far the case seems not to be proven.