Banking watchdogs played "war games" envisaging a crisis at Northern Rock and HBOS three years before the first signs of danger in the banking sector, it has emerged.
In 2004, regulators put the two lenders at the centre of a scenario focusing on a sudden crisis in the property market, according to the Financial Times.
The war game – conducted by the tripartite authorities of the Financial Services Authority, the Bank of England and the Treasury – long predated the start of the credit crunch in August 2007 and the subsequent run on Northern Rock, which eventually had to be nationalised.
The vulnerability of HBOS's business model became apparent last September after the collapse of Lehman Brothers, when the government brokered an emergency takeover by a rival bank, Lloyds TSB. The combined group, now known as Lloyds Banking Group, has had to be bailed out by the government, which owns 43% of its shares.
The revelation that the two doomed banks were the subject of a risk-planning exercise five years ago calls into question the idea that the run on Northern Rock and later banking crisis were unforeseeable.
The Bank of England's governor, Mervyn King, had alluded to the exercise in an interview in 2005, noting: "To make it real, we've actually had to simulate problems in real live institutions … the skill in constructing it is to make it plausible."
The war game was a response to unease about some banks' exposure to the property market and foreign money and the potential risk to them if these funds dried up. It examined Northern Rock's business model and the potential knock-on effect on HBOS, which was the UK's largest mortgage lender at the time.
Although it showed that the banks were vulnerable to turbulence, the watchdogs felt their business models were not overly risky and decided against forcing any changes on them, the FT reported.
The FSA and Bank of England told the paper that the war game had not been designed to predict bank failure, but had focused on regulatory practices.
