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FSA warns on greater risk to global economy


LONDON—The U.K. Financial Services Authority says that the firms it regulates should upgrade their stress tests because it believes that the global economy is more exposed to risk than it was at this time last year.

In its annual "Financial Risk Outlook," the FSA said that the overall outlook for the global economy continues to be benign. But it believes that there is "an increasing risk that it will become more unsettled."

The regulator says that the key factors that drive the heightened instability are increasing geopolitical risks, that is says escalates the probability of an "event risk;" 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, said the FSA.

The regulator said that a recent review of stress tests found that some firms could be underestimating the probability of severe events.

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."