Bank of England to widen scope of tests for systemic risks

The Bank of England will seek to broaden its investigation into the vulnerability of organisations to systemic risk, with a new stress test for non-bank financial markets planned for next year.

The decision to broaden the scope of its stress tests comes after a tumultuous autumn in the UK, marked by September’s implosion of UK pension funds, which forced emergency interventions by the bank, as well as exposing gaps in policymakers’ understanding of systemic risk in key markets. 

The central bank’s Financial Policy Committee (FPC) stepped in after a massive sell-off of UK government bonds — known as “gilts” — following the new government’s fiscal policy announcements on 23 September, in a ‘budget’ that is now widely viewed as disastrous, and eventually led to the departure of Britain’s shortest-serving Prime Minister, Liz Truss.

The plunge in bond values caused panic in particular for Britain’s £1.5 trillion ($1.69 trillion) in so-called liability-driven investment funds (LDIs).

The BoE announced the stress test exercise in its latest financial stability update, where it noted that while UK households are being “stretched” by rising interest rates and soaring inflation, they were not yet showing “widespread signs of financial difficulties” or an inability to repay loans. 

The UK’s corporate sector and banks were both described as well positioned to withstand the worsening economic outlook, with the non-bank financial sector coming in for the most severe warnings from the senior bank officials and external experts who make up the FPC. 

However, the FPC said international regulators need to “urgently . . . develop and implement appropriate policy responses” to tame risk stemming from non-bank financial institutions, whose share of the global financial services market has more than doubled since the 2007-08 financial crisis.

In the meantime, the bank is planning a “deep dive into specific risks” into financial markets dominated by institutions such as hedge funds, mutual funds and pension funds so that policymakers can assess the scale of risks “and propose solutions”.