Banks face toughest conditions since '90s

By Clara Ferreira-Marques

LONDON (Reuters) - Banks are navigating their choppiest waters since the early 1990s and face growing risks including a loss of public confidence, escalating consumer defaults and a rise in financial crime, the regulator warned.

In its annual review of top risks for the year ahead for the financial sector, the Financial Services Authority (FSA) warned that some banks could find their business models under strain if wholesale funding markets remain constricted, forcing them to pull back on lending.

That, it said, would add to already heavy pressures on indebted consumers.

The regulator said on Tuesday that a third of UK mortgages written between April 2005 and September 2007 were considered to be high risk, including high loan-to-income ratios, high loan-to-value ratios and long terms.

The FSA, which said the focus had shifted away from unsecured debt this year, warned last year that at least 1.4 million short-term fixed-rate mortgages would be reset in 2008, in a context of weaker property prices.

"The spectre of consumers having debt that exceeds the value of their property is not something that has materialised yet but it is certainly a risk we have to take seriously," said Sarah Carlson, head of global risk and risk aggregation at the FSA.

"We are also concerned that consumers are ill-prepared for a deterioration in economic conditions and may have placed too much reliance on their ability to obtain cheap credit and housing wealth to sustain their consumption levels."

She said the market was expecting the Bank of England to cut rates, but said higher borrowing costs could make it harder for lenders to pass on that reduction to mortgage clients.