City watchdogs warn that credit crunch could lead to disastrous surge in home repossessions

The Financial Services Authority is worried that both the banks and millions of homebuyers face "impossible" financial stress.

It put the country's banking giants on notice that they must take steps to protect their finances amid fears of a repeat of the Northern Rock debacle.

And it signalled a need to protect home-buyers as evidence emerged that banks are taking a ruthless approach to those who fall behind on their mortgages.

The FSA's retail managing director, Clive Briault, sounded the alarm in uncharacteristically blunt terms in a speech to industry body the Council of Mortgage Lenders.

He said there is every reason to believe the current crisis in financial markets "will worsen further".

He advised banks to draw up contingency plans to prepare for "the worst outcomes".

The comments will concern families already under pressure from spiralling mortgage payments, higher household bills, a record £1.3trillion in personal debt and rising transport costs.

A survey of consumer confidence - which gauges the health of household finances - to be published by the Nationwide today showed its biggest ever fall in November.

Meanwhile, economists warned that a slump of 45 per cent in the share price of the country's house builders in the past six months suggests house prices will fall.

The credit crunch, triggered by the collapse of thousands of risky "trailer park" mortgages in the U.S., has left banks with huge losses and unwilling to lend to one another.

This has made it much more expensive for banks to borrow money in order to pay off debts and offer new home loans and forced Northern Rock to go cap in hand to the Bank of England for nearly £30billion to stay afloat.

Officials at the FSA fear other banks and finance firms could suffer the same fate. Mr Briault said: "There is a very real prospect that conditions will worsen further into next year, in terms of both liquidity and credit risks.

"Firms should therefore be assessing their funding and liquidity positions; undertaking robust stress-testing to reflect current and prospective market conditions, and considering contingency plans against the worst outcomes."

Mr Briault voiced particular concern for the 1.4million Britons whose short-term fixed rate deals will end over the next 12 months.

"Many of these borrowers will find it difficult - if not impossible - to re-finance their mortgage on favourable terms," he warned.

He said the resulting increase in monthly repayments "may prove too much for many of them".

The Council of Mortgage Lenders predicts repossessions will rise by 75 per cent this year to reach 30,000.

It suggests this figure will rise again to some 45,000 in 2008.

However, some analysts believe the figure could hit 70,000, close to the peak during the 1990s' bust.

Citizens Advice and the homelessness charity Shelter say banks, building societies and finance firms are taking a ruthless line.

The head of consumer policy at Citizens Advice, Sue Edwards, said: "Lenders aren't currently doing all that they can to help borrowers in mortgage arrears."

Mr Briault said the FSA will begin an "urgent" inquiry in an effort to prevent exploitation. The results of will be available in March.

The director general of the Council of Mortgage Lenders, Michael Coogan, urged those facing rising repayments to speak to their lender as soon as possible "to avoid becoming an arrears statistic or a possession case".