Fitch as a fiddle

This week’s Fitch report on stress-testing the banks in the event of a housing crash has produced a muted response but one divided equally between consternation and joy.

On the one hand, the idea that Australia can escape a 40% house price crash with a simple $15 billion loss, divided between banks and mortgage insurers, hardly seems to pass the laugh test.

On the other hand, the banks and their supporters are no doubt chuffed as hell at the good management this suggests.

This blogger has spent the last couple of days digging and can now throw some light on the issue.

The Fitch stress test is a simple credit risk assessment for the big banks’ mortgage portfolios. That is, Fitch asked what would the losses be for the banks in the event of three housing bust scenarios, one mild, one medium and one severe.

The test is a straight three year model without econometrics.

It makes no reference to any macroeconomic scenario.

Nor does it take account of losses in other areas of the banks’ greater portfolio of consumer and business loans.

Nor does it take account of the liability side of the banks’ balance sheets and the liquidity risk buried in their wholesale borrowings.

In short, the test is the functional equivalent of judging the safety of an aircraft by jumping up and down on its wings. If they hold, we’re cleared for takeoff. The coughing engine, missing tail and dead pilot get ignored.

Still, Fitch has been good enough to provide the report slides, so judge for yourself.

Fitch Presentation