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May be as bad as early 90s

• Robert Peston
• 9 Aug 08, 12:00 AM

The City watchdog, the Financial Services Authority, has told the UK's banks to make sure they are strong enough to withstand serious losses on mortgages and other lending for the next two or three years.

In an exclusive interview with me, the FSA's chief executive, Hector Sants, was asked whether the difficulties for banks could be as bad as they were in the early 1990's and whether losses on lending would continue to be a problem for up to three years.

Mr Sants replied that he would expect banks "to plan on that type of assumption". The recession and property market downturn of the early 1990s saw British banks suffer debilitating losses over an extended period.

He said "you'd expect a regulator to be naturally more pessimistic possibly than the market place as a whole".

He added that he expressed his opinions "fairly forcibly" to banks that they needed to raise capital, so that they could be confident of weathering the economic downturn.

Royal Bank of Scotland, Barclays and HBOS have between them raised 拢20bn of new equity capital. It's understood that the FSA had to exert a fair amount of pressure - to be "directive" in Mr Sants' words - before the banks agreed to raise as much.

Figures disclosed by banks in their results and in aggregate by the Council of Mortgage Lenders show that growing numbers of mortgage borrowers are having difficulties keeping up the payments. There has also been a sharp rise in repossessions.

However not all banks have started to incur significantly increased losses on their UK loans. The recent falls in their profits - and the 拢691m loss suffered by Royal Bank of Scotland - stemmed mainly from their investments linked to the dire US subprime lending market.

There has been a sharp rise in charges for losses on mortgages reported by HBOS, Northern Rock and Bradford & Bingley. But Royal Bank of Scotland actually reported a fall in losses on personal loans and mortgages made to British customers.

Most analysts expect losses on mortgages to rise for most banks over the coming months.

In relation to the causes of the credit crunch, Mr Sants disclosed that the FSA is unhappy at the way banks rewarded their star bankers during the boom years.

He says that there was an incentive on these bankers to take excessive risks with their firms' capital. That foolish risk taking has come home to roost in the form of massive losses on investments linked to US subprime lending.

Mr Sants said that the FSA would find a way to penalise any banks which continue to incentivise staff to take dangerous risks. He said there would be "consequences" for banks that pay employees too much for doing imprudent deals.

The will be broadcast tonight on the News Channel series, Leading Questions.

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