FSA calls for tougher bank liquidity tests

By Clara Ferreira-Marques

LONDON (Reuters) - Banks need to carry out tougher tests to ensure they can withstand liquidity shocks, including testing possible strains from off-balance sheet vehicles like conduits, the regulator said on Wednesday.

In a long-awaited discussion paper reviewing the liquidity regime, the Financial Services Authority said banks also need to draw up better contingency plans and to update the regulator more frequently on their liquidity position.

Liquidity risk has been a major issue for all regulators since the start of the global credit crunch and a priority for the FSA, which is under fire for its role in the near-collapse of mortgage bank Northern Rock NRK.L.

In the aftermath of Northern Rock, the FSA had said it would re-examine some aspects of liquidity regulation -- particularly stress-tests carried out by banks -- and it had been expected to put forward some proposals by the end of 2007. The regulator has also said it wants international standards, to accommodate international banking groups, not national regimes.

In Wednesday's document -- a discussion paper ahead of more formal proposals next summer -- the FSA gave little detail on its "belt-and-braces" approach to liquidity supervision.

But the regulator highlighted its areas of concern, including the tests carried out by banks to ensure they can survive both extreme and lengthy liquidity crises.

Northern Rock, for example, remained solvent after August's crisis, but was unable to fund its lending after the summer's liquidity crunch became both chronic and long-lasting. Its "stress tests", along with those of all banks, were drawn up by the firm itself -- but did not cover a crunch the lender's management said they and others had been unable to predict.

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