The Bank of England aims to develop the lending capacity of non-bank financial institutions.
The bank said in a final report on its system-wide exploratory scenario exercise that it was doing so to address potential liquidity challenges in core financial markets that could threaten financial stability in the UK.
He emphasized in the report that this exercise explored how the UK financial system – including banks, insurance companies, pension schemes, hedge funds, asset managers and central counterparties – would respond to a market shock.
It found that while non-bank financial institutions have become more flexible in recent years, this may change over time, and these changes could be amplified by the financial system as a whole, according to the report.
Nonbank financial institutions may need more liquidity during times of market stress, but banks are unlikely to provide all the additional repo financing sought by nonbank financial institutions, the report said.
Having concluded this during the exercise, the bank plans to address this challenge with further policy action to increase the flexibility of the repo market and with other central bank facilities, according to the report.
“The Bank is expanding its tools through the Temporary Non-Bank Financial Institutions Repo Facility (CNRF), which will allow the Bank to provide repo directly to eligible non-bank financial institutions if necessary to address severe imbalances in the government bond market,” the report said.
Bank of England Deputy Governor Sarah Breeden said at a conference in February that more research should be done on non-bank lenders to help prevent a “credit crunch” that could result from the withdrawal of hedge funds, pension funds, asset managers and insurance companies.
“A shift in market-based finance’s willingness to lend to companies, especially those that may be highly leveraged, would have significant implications for the real economy – a credit crunch originating from market-based finance rather than bank lending,” Breeden said at the time.
Potential challenges posed by non-bank financial institutions have also been noted at the global level.
In July, Financial Stability Board Chairman Klaus Knott said recent “incidents of market stress and liquidity shortages” showed that non-bank financial institutions could exacerbate systemic risks to the larger financial system.
In a letter to a group of finance ministers and central bank governors, Knott said: “Many of the fundamental vulnerabilities that contributed to these incidents remain largely in place, leaving the global financial system vulnerable to further shocks.”
