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FSA warns of need for better stress testing

The FSA has warned firms to improve the stress testing of their businesses after its risk report highlighted the greater impact a shock could have in the next 18 months.
While the FSA says the overall outlook for the global economy continues to be benign, its Financial Risk Outlook for 2007 identifies an increasing risk it will be more unsettled.
It says key factors creating this warning include increasing geopolitical risks, increasing 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.
The FSA says these trends mean the impact of a shock to the financial system would be much greater now than two or three years ago.
FSA chairman Callum McCarthy says: “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.”

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