Financial Policy Summary and Record – March 2023

The Bank of England (BoE) has published its Financial Policy Summary and Record (03/2023) which typically summarizes key market developments and vulnerabilities in the last business quarter (Q4/2022) as identified by the Financial Policy Committee (FCP). Due to recent developments in the banking sector, however, this quarterly report also addresses issues that arose in the past month. Some highlights of the document are noted below; for more detailed, comprehensive information, please consult the document itself.
(1) U.S. bank failures: The recent bank failures in the U.S. and the financial difficulaties of Swiss bank Credit Suisse have put tremendous pressure on share prices of banks around the globe. Despite the fact that the situation has largely been stabilized by local regulators – Credit Suisse was bought by UBS, Silicon Valley Bank was put under receivership and subsequently sold – tensions remain in the market. This is primarily due to the fact that the economic outlook ist still highly uncertain with a high level of inflation and that many monetary authorities keep on tightening fund flows.
(2) UK bank resilience: UK banks are highly resilient and have sufficient capital to withstand the current situation. Their profits are „healthy“, their aggregate Common Equity Tier 1 (CET1) ratio stands at 14.6% (major banks) and at 18% (smaller institutions). Additionally, banks have implemented sound interest rate risk management practices and recent stress tests have shown that they can withstand high level of interest rates over a prolonged period of time. In response to the current market situation, many institutions have tightened their lending standards to ensure less credit defaults. To ensure sufficient lending activity in the UK market, the Committee does not find it necessary or even counterproductive to raise the current countercyclical capital buffer rate beyond 2% which will be effective on July 5, 2023.
(3) The resilience of liability-driven investment funds (LDI funds): Having recovered from the recent surge in yields of UK guilts, the FCP strongly recommends LDI funds to increase their risk management practices particularly with respect to concentration risk, liquidity management, and capital resources. In its newly published recommendations on LDI funds minimum resilience (please see EventID 20431 for more information), the Committee advises funds to be prepared for and incorporate in their risk management processes yield shocks in the gilt market of „around“ 250 basis point. In fact, they should be able to absorb such shocks without having to engage in asset sales which may trigger a further downward pressure on market prices of gilts and other assets, contributing even further to market stress.
(4) The resilience of money market funds: As money market funds and their investment strategies are of utmost significance in the UK financial market, their resilience must be ensured. Currently, there are no acute concerns over their operations. However, the FPC finds that the overall resilience must be improved to reduce systemic risk. Therefore, a consultation will soon be launched to propose measures that will
– ensure that redeeming investors pay the costs for their redemptions; and
– ensure that MMFs hold sufficient liquid assets to meet sudden or increased redemption requests.