Bank of England tackles shadow finance –
The Bank of England wants to fight “shadow finance” by testing non-bank financial institutions. A strategy that can be explained by the historic shock caused by these institutions in the British debt market, which forced the Central Bank to intervene.
The Bank of England will test the resistance of non-bank financial institutions, the “shadow finance” particularly responsible for the shock in the British debt market in September, the monetary authority announced on Tuesday.
BoE governor Andrew Bailey said in a letter to the finance minister that the Central Bank will “conduct a scenario exercise that will focus on risks from non-bank financial institutions” such as investment funds active in the British debt market.
In September, after former prime minister Liz Truss’s hugely expensive but unspent budget announcements, the government’s borrowing rate began to climb rapidly.
“Investment funds were then forced to sell in an illiquid market,” the minutes of the BoE’s Monetary Policy Committee noted, causing a historic shock to the British debt market and forcing the Central Bank to intervene.
The BoE often does not regulate offshore LDI funds (liability-based investments) and advises the pension fund regulator, as well as European regulators, to ensure that these funds maintain a sufficient level of collateral to avoid such a shock in the future.
“Reforms by regulators to improve the resilience of non-bank financial institutions are both necessary and urgent,” Bailey said at a news conference Tuesday. Especially since the share of non-bank finance has increased in recent years and “is the source of almost half of the assets loaned from the global financial system”, the BoE emphasizes.
In addition to the shock caused by LDIs, the Bank of England recalls the massive asset sales that caused the collapse of international markets at the start of the Covid-19 pandemic, or the rise in commodity prices in early 2022. From the occupation of Ukraine.
If in these cases the price movement started for geopolitical reasons, their amplitude was multiplied by less regulated players than banks, such as investment funds, pensions or speculative (hedge funds), sometimes with risky investments.
Therefore, the BoE wants to test non-bank financial institutions based on the model of “stress tests” it has done for traditional banks since 2014.
The funds or companies that will be tested, or the disaster scenario that will be presented to them, have not yet been determined and “more details will be shared in the first half of 2023,” the Bank said.
According to BoE forecasts, traditional banks can withstand the long-term recession that has already started in the UK.
On the other hand, rising interest rates are weakening British households, which are increasingly indebted, while prices are rising – inflation has reached 11% – and the UK economy is, according to many forecasts, heading into recession.
The BoE will publish its final monetary policy decision of the year on Thursday, with a further hike in the key interest rate widely expected by the market.
According to the BoE, half of the home owners who pay their mortgage for around 4 million households will see the average payment rise from £750 to £1,000 by the end of 2023.
This “could lead to more defaults on mortgage loans, but also on other forms of borrowing such as credit cards or unsecured loans, as well as a marked reduction in consumption,” the BoE notes. He also notes that rising prices, unless accompanied by falling property prices, will make it harder to buy a first home.
“Real estate prices have risen by 20% in the last two years. So there is room to get into a negative equity position,” nuanced the BoE’s Jon Cunliffe, when property prices fall below the cost of credit.