The Bank of England (Bank) has initiated the scenario phase of the System-wide Exploratory Scenario (SWES), a comprehensive assessment aimed at understanding the dynamics of banks and non-bank financial institutions in stressed market conditions.
Launched in June 2023, the SWES involves more than 50 financial market participants, including major banks, insurers, central counterparties, asset managers, hedge funds, and pension funds.
The primary objectives of the SWES are to enhance understanding of the risks associated with non-bank financial institutions and investigate how behaviours in both non-bank financial institutions and banks during stress can amplify shocks in markets, potentially posing risks to UK financial stability, the bank noted.
Participants have been provided with a severe yet plausible stress scenario, featuring faster, wider-ranging, and more persistent shocks than those observed in recent periods of market instability, such as the ‘dash for cash’ in March 2020 and the Liability Driven Investment (LDI) episode in September/October 2022, the bank said.
The hypothetical scenario includes a ten-day shock to rates and risky asset prices.The Bank emphasises that the exercise is not a forecast but rather a tool to improve understanding of how financial institutions respond in stressed conditions.
Participants are tasked with assessing the impact of the hypothetical stress scenario on their businesses and outlining the actions they would take in response. The Bank will subsequently evaluate the system-wide consequences of these actions.
The scenario incorporates elements from recent market events, with sharp increases in UK government borrowing costs, sterling investment-grade corporate borrowing costs, and sovereign yields across various countries.
The severity of the aggregate shock, combined with the rapid market moves in the first three days of the exercise, sets this hypothetical stressed scenario apart from historical episodes.
Participants, which include large banks, insurers, central counterparties, asset managers, hedge funds, and pension funds, are currently evaluating the impact of the stress scenario on their businesses. They are expected to submit their responses to the Bank by January 2024, the bank noted.
The second round of the scenario phase, reflecting participants’ actions in the first round, is scheduled for launch in Q2 2024. The Bank plans to publish a final report on SWES findings by the end of 2024.
Collaborating closely with the Financial Conduct Authority and The Pensions Regulator, the Bank aims to gain valuable insights into how liquidity needs and behaviours of non-bank financial institutions change under stress.
The SWES also focuses on the role of banks, central counterparties, and other market participants in ensuring the resilience and stability of UK financial markets.
