Bank of England to run stress tests on non-bank financial institutions

The Bank of England is set to launch the first ever stress test on financial institutions outside the banking sector after the recent mini-budget market turmoil that saw the near-collapse of some pension funds.

More needs to be done to ensure that the non-bank financial sector is more resilient and does not pose a threat to the UK’s financial stability, the Bank’s Financial Policy Committee (FPC) said.

The Bank already stress-tests eight of the UK’s leading banks, such as Barclays, NatWest and Lloyds Banking Group, to determine how well they can withstand shocks to the economy.

It involves putting them under hypothetical worst-case scenarios like high inflation, spiking interest rates, high unemployment and economic decline, to see if they could still support households and businesses effectively.

But up until now there has been no such scenario for non-banks, such as pension funds, hedge funds, insurers, and private equity lenders.

The FPC said the stress tests will be exploratory and will take into account potential scenarios which go beyond historical experience.

It comes after yields on UK government debt surged to historic levels in September after former chancellor Kwasi Kwarteng’s disastrous mini-budget sparked market chaos.

The Bank of England was forced to step in and purchase about £19 billion worth of gilts to stabilise the market and prevent some pension funds from collapse.

In particular, it exposed the instability of liability-driven investment (LDI) funds – the investment strategies at the centre of the pension crisis, the FPC said.

It is important that these financial stability risks are avoided in the future, it stressed.

The governor of the Bank of England, Andrew Bailey, said there have been a number of “incidents” in the sector that need to be addressed, and the Bank needs to get a better understanding of what causes these.

He said: “The post-financial crisis reforms were very much, and rightly, focused on the banking sector.

“But we have now had a whole series of non-bank incidents across different jurisdictions, and I think it is absolutely critical to recognise that this is a sector that is highly internationally diversified.

“The pooled LDI funds, which were the main source of the challenge we had, are in almost all cases actually based outside this country. So that emphasises why it is so important that we take action.”

Sir Jon Cunliffe, the deputy governor for financial stability, stressed the exploratory nature of the stress tests and the importance of getting a bigger picture of how banks and non-banks work together.

He added: “I think the things we’ve seen… have made people much more aware of how liquidity resilience in non-bank finance can cause systemic issues, and I think there is much more of a will to solve these problems.

“But we’ll know by the end of next year what we’ve come up with.”