The Bank of England has released a quarterly report on the state of the UK’s financial system, calling for tougher rules governing pension schemes and major lenders outside of the banking mainstream. The report cites the need for increased resilience among non-bank finance companies that lend trillions of dollars globally, as well as increased reserves for pension funds. The central bank’s financial policy committee (FPC) stated that the UK’s major banks remain resilient to further financial shocks, but there is a greater urgency to make non-bank finance companies more resilient to protect the wider financial system.
The FPC’s report highlights the need for funds using liability-driven investments (LDIs) to face new stress tests, particularly after the crisis that followed Kwasi Kwarteng’s poorly received mini-budget in September. Pension funds hit by the crisis in LDIs will need to increase their reserves to prevent a similar occurrence. Additionally, the FPC is monitoring investor behaviour following the recent flight to safety triggered by the collapse of the US bank Silicon Valley Bank and the rescue of the Swiss lender Credit Suisse.
The report further notes that the global financial system is still adjusting to higher interest rates in the US, euro area, and the UK, which could lead to difficulties for some lenders. The FPC concludes that the pressure on households and companies in the UK has eased since its last review in December, with reduced gas prices and lower unemployment rates making it more likely that they can cope with higher debt payments. Banks are also in a strong position to handle domestic and overseas-generated shocks, with large liquidity asset buffers, around two-thirds of which are in the form of cash or central bank reserves. Banks are also generating bigger profits to protect themselves, allowing the UK banking system to support the economy in a period of higher interest rates.
The FPC calls for increased resilience among pension funds and other major institutions in the financial system, including money market funds, when investor panic triggers a flight to safety across global money markets. The report emphasizes the importance of improving the resilience of money market funds as a means of mitigating systemic risk in both the UK and the global financial system. Although banks have received increased attention since the 2008 financial crisis, there are many intermediaries in the financial system, such as money market funds, that have avoided strict regulations requiring them to comply with certain standards.
Over the past decade, the Bank of International Settlements, which is a Swiss-based advisory organization for central banks, has cautioned that the growing impact of non-bank lenders must be taken into account when formulating financial regulations. However, the FPC has suggested that it may take several years for the UK to take any action, as a consultation paper is not expected to be released until later this year.
In conclusion, the Bank of England’s report highlights the need for increased resilience among non-bank finance companies and pension funds. The global financial system is still adjusting to higher interest rates, which could lead to difficulties for some lenders. The major banks in the UK are well-equipped to manage both domestic and overseas-generated shocks, thanks to their sizable liquidity asset buffers and improved profitability. However, money market funds and other intermediaries in the financial system need to be subject to more stringent rules to reduce systemic risk. While it may take several years for the UK to take action, the FPC’s report serves as a warning that the wider financial system needs to be protected.