The Bank of England (BoE) is planning to develop a new lending tool for insurers, and other non-bank financial institutions like pension funds, to provide access to emergency cash during times of market stress.
This new tool is to be created to help avoid a repeat of last year’s bond market turmoil, Andrew Hauser, the BoE’s executive director for markets, stated in a recent announcement.
The BoE has a well established range of tools to lend to banks if they struggle to get cash during times of stress. However, there is no equivalent for non-bank financial institutions (NBFIs) – which includes broker-dealers, non-bank lenders, pension funds, insurance companies and other investment vehicles.
Therefore the BoE has decided to develop this “ambitious programme to build a new generation of lending tools to help underpin financial stability during periods of exceptional liquidity stress, channelling liquidity directly to resilient NBFIs when capacity constraints prevent banks from lending in sufficient size.”
“The driver for building these new tools comes from our statutory responsibility to protect and enhance the stability of the entire UK financial system, encompassing banks, non-banks and markets,” Hauser explained.
“The way in which NBFIs pose systemic liquidity risks is less immediately obvious [compared to banks]. In particular, their funding models may be more opaque, wholesale-focused or longer maturity than traditional bank sight deposits. But the reality is that many NBFIs are still exposed to liquidity mismatch.”
He continued: “In executing these strategies, NBFIs are often reliant on concentrated markets, creating a complex web of interconnections between themselves and the wider financial system. While many NBFIs are individually small and non-systemic, common behavioural responses to shocks can still generate systemic market events.
“In such circumstances, large losses on (leveraged or unleveraged) investment positions, investor redemptions or margin calls, or operational constraints can lead to forced selling in core markets that overwhelms market capacity, causing self-reinforcing price spirals and other forms of dysfunction that threaten financial stability.”
Hauser highlighted that the “impetus for this work is real and pressing” as NBFIs have introduced important new sources of systemic risk, and the BoE current toolkit, although effective, is incomplete.
Lending to banks during past crises did not always find its way to NBFIs facing liquidity issues, and buying and selling assets directly posed financial and policy risks to the BoE, Hauser said.
To reach their goal, a new lending tool for NBFIs, a series of daunting policy and operational questions needs to be solved first.
In his speech, Hauser also said the BoE would look at expanding the lending facility to a wider range of non-banks over time. At the same time, he warned that the programme was not aimed at reducing financial firms’ need to guard against day-to-day risks.
He said: “It is central banks’ job to protect the system against genuine threats to stability. But it is firms’ job to protect themselves against a wide range of less severe shocks, and we cannot afford to conflate the two. To reach our goal, we must undertake this journey together.”
