BoE warns of risks from non-banks in times of crisis

MARTIN ARNOLD AND ORTENCA ALIAJ

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More work is needed to tackle risks out­side the bank­ing sec­tor, accord­ing to a Bank of Eng­land study which found that a mar­ket crisis would be amp­li­fied by fire sales of assets by pen­sion funds, hedge funds and other investors.

The BoE said a sharp rise in sov­er­eign and cor­por­ate bond yields caused by “a sud­den crys­tal­lisa­tion of geo­pol­it­ical ten­sions” would cause “sig­ni­fic­ant losses” for non-bank insti­tu­tions — such as pen­sions funds, hedge funds and private equity firms — for­cing many to sell assets and amp­lify the shock.

The exer­cise required a group of more than 50 City of Lon­don insti­tu­tions to model how a period of intense stress would ripple through the increas­ingly import­ant non-bank sec­tor. It under­lines how reg­u­lat­ors are shift­ing their focus to risks arising out­side the bank­ing sys­tem.

The so-called sys­tem-wide explor­at­ory scen­ario — which included the the­or­et­ical default of a hedge fund — fol­lows sev­eral big mar­ket upheavals due to fal­lout from the pan­demic and recent geo­pol­it­ical tur­moil.

Gov­ernor Andrew Bailey said yes­ter­day that the BoE was con­cerned about the “increased risk of global frag­ment­a­tion”. US pres­id­ent-elect Don­ald Trump has threatened to raise tar­iffs on imports from coun­tries includ­ing Mex­ico, Canada and China, fuel­ling fears of a hit to eco­nomic growth.

The BoE warned trade ten­sions “could weigh on growth and increase uncer­tainty of eco­nomic out­comes, includ­ing around infla­tion, which could feed into volat­il­ity in fin­an­cial mar­kets”, as well as caus­ing “dis­rup­tions to cross­bor­der cap­ital flows”.

Bailey said its “world-lead­ing” exer­cise to model risks from non-banks had “revealed sev­eral mis­matches in expect­a­tions among mar­ket par­ti­cipants”, adding that it also “high­lighted a num­ber of remain­ing risks and vul­ner­ab­il­it­ies that will be import­ant to address”.

The BoE said resi­li­ence was “com­par­at­ively high” in some areas, includ­ing money mar­ket funds, insurers and liab­il­ity-driven invest­ment funds in pen­sion schemes, because of lower debt levels.

But it said non-banks could still cause “greater amp­li­fic­a­tion” of future shocks. One con­cern is the risk of liquid­ity dry­ing up in the repo mar­ket, in which fin­an­cial groups can raise money against assets such as gilts. Another worry, accord­ing to the BoE, is that the cor­por­ate bond mar­ket could seize up due to heavy selling by investors.

The find­ings were released along­side the res­ults of the BoE’s latest stress test of banks, which showed they could com­fort­ably with­stand two crisis scen­arios.