Financial regulators acknowledged the possibility of unemployment rising by another 1.5 million and the average house price halving to only £93,000.

The grim scenario was revealed by the Financial Services Authority (FSA), which is in charge of regulating banks and making sure that they have sufficient strength. It revealed that it has been stess-testing banks, applying fictional scenarios to see how their balance sheets could cope with a deep, prolonged recession.

The depicted scenario, which also envisages the recession carrying on for at least another year and a half, was not a forecast of what was likely to happen, the FSA said. It was intended to test how banks would cope if confronted with the worst economic downturn since the Second World War.

The key assumptions in the stress test were that the economy would shrink by 6 per cent from peak to trough with growth not returning until 2011 and trend growth not until 2012. The regulators also assumed unemployment rising to 12 per cent of the workforce, or 3.7 million people, which is 1.5 million more than the present number and would be a higher level of joblessness even than in the recession of the early 1980s.

Finally, the FSA posited a 50 per cent fall in house prices from their peak and a 60 per cent fall in commercial property prices - office blocks and shops.

So far, house prices have fallen by 19 per cent from their peak in October 2007, according to the Nationwide Building Society. The FSA scenario envisages the impact of a fall from £186,000 then to a low point of £93,000.

Implied, but not explicitly stated in the FSA statement, was that all banks and building societies passed the test — their capital cushions never falling below 4 per cent of assets even after such a hypothetical economic storm.The FSA has been under intense pressure to provide more details of its stress-testing after the United States published its findings.

The FSA emphasised that its method took place continuously as part of continuing supervision — and was different from the one-off American exercise covering 19 banks. It said it would not be publishing details of test results on individual banks.

Barclays recently avoided having to raise fresh capital or take part in the Government's Asset Protection Scheme (APS) this year after passing its stress test. The FSA also applied the tests to Royal Bank of Scotland and Lloyds Banking Group as a condition of their participation in the APS, a measure giving them protection against losses on hundreds of billions of pounds of toxic loans and investments.

Analysts said the stress test parameters were, if anything, not severe enough. The market is already expecting a peak-to-trough fall in GDP of 4.5 per cent and unemployment peaking at 10.5 per cent, “which is not significantly better than the assumptions made,” analysts at Credit Suisse commented. However, the house price scenario did look more extreme, it added.

The FSA also confirmed for the first time that it did take into account the possibility of banks raising fresh capital or making emergency asset sales to bolster balance sheet ratios. This is thought to be how Barclays passed its stress test. Worries about the solvency of banks have eased in the wake of the APS and signs that the downturn may be bottoming out.

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