By Mark McSherry
The UK’s central bank, the Bank of England, said it has launched its first system-wide liquidity “stress test” to establish how big banks, insurers, clearing houses and investment funds respond collectively during extreme stresses in markets.
The BoE had said in December that investment funds and other non-bank financial institutions would face their first stress test to apply lessons from the near-meltdown in the UK’s pension fund sector in September.
The central bank said working closely with the Financial Conduct Authority and the Pensions Regulator, it will bring together data and information from various parts of the financial system to develop system-wide and sector-specific insights – thereby accounting for “amplification effects” within the financial system.
“The exercise aims to improve understanding of the behaviours of banks and non-bank financial institutions (NBFIs) in stressed financial market conditions,” said the central bank.
“It will explore how those behaviours might interact to amplify shocks in UK financial markets that are core to UK financial stability.
“Participating firms will include large banks, insurers, central counterparties and a variety of funds (pension funds, hedge funds, and funds managed by asset managers).
“This reflects the wide range of institutions engaged in UK financial markets. Participants will be actively engaged in both the design and execution of the exercise.
“Recent events have shown that market-based finance (MBF) has been increasingly prone to sudden liquidity stresses during periods of market volatility.
“The March 2020 ‘dash for cash’ and the adverse gilt dynamics seen in September 2022, which required Bank intervention, act as examples.”
The central bank’s deputy governor for financial stability Jon Cunliffe said: “We regularly run scenario exercises with a variety of firms which support our efforts to protect and enhance the stability of the UK financial system.
“The launch of this exercise will provide valuable insight into the system-wide dynamics for banks and non-banks following a severe but plausible stress to financial markets.”