He also noted that the Bank of England intends to work towards having the capacity to lend to non-bank financial institutions (NBFIs).
The bank said in a final report about its system-wide exploratory scenario exercise that it is taking that step to address potential liquidity challenges in core financial markets that could endanger the United Kingdom’s financial stability.
The report added that this exercise tested the U.K. financial system—consisting of banks, insurers, pension plans, hedge funds, asset managers, and central counterparties—against a market shock.
It determined that although NBFIs have become more resilient in recent years, that may change in the future, and that might be a big factor through the financial system, the report said.
NBFIs could need more liquidity during times of market stress, but banks are unlikely to provide all the additional repo financing the NBFIs seek, the report said.
Having found this during the exercise, the bank plans to meet this challenge with further policy work to raise repo market strength and with other central bank facilities, per the report.
“The Bank is expanding its tools with the Contingent NBFI Repo Facility (CNRF), which will allow the Bank to provide repo directly to eligible NFBIs if required to address severe gilt market dysfunction,” the report said.
Bank of England Deputy Governor Sarah Breeden said at a conference in February that there should be more research into non-bank lenders to help prevent a “credit crunch” that could result from a pullback by hedge funds, pension funds, asset managers, and insurers.
“A shift in the readiness of market-based finance to lend to corporations, particularly those perhaps that are highly leveraged, would have significant substances for the real economy—a credit crunch sourced in market-based finance rather than bank lending,” Breeden said at the time. Possible challenges posed by NBFIs have also been noted on the global level.
In July, Financial Stability Board (FSB) Chair Klaas Knot said recent “incidents of market stress and liquidity strains” have shown that NBFIs can cause or worsen systemic risks to the larger financial system.
Writing to a group of finance ministers and central bank governors, Knot said: “Many of the underlying exposures that contributed to these incidents are still largely in place, leaving the global financial system susceptible to further shocks.”
