(Bloomberg) -- The Bank of England is hunting for better ways to keep a close eye on non-bank financial institutions as it looks to track escalating risks posed by the sector.
The central bank has spent months probing how a bevy of investment banks, insurers, central counterparties, hedge funds and other asset managers can handle different forms of stress as part of its so-called system wide exploratory scenario. Still, Governor Andrew Bailey said regulators have already realized there’s a need for further tools to monitor these players.
“It is more in the way of a flow test – simulate shocks, let them flow through the system and see what happens,” Bailey said in prepared remarks at Bloomberg’s Global Regulatory Forum in New York. “We need to develop more of these tools of surveillance of risks.”
The system-wide exploratory scenario was designed to improve the central bank’s understanding of how banks and non-banks behave in stressed conditions. At the heart of regulators’ concern is a shift in risk-taking from banks to non-banks since the global financial crisis.
Bailey said the central bank will reveal the results of the latest exercise by the end of the year.
“It’s an opaque and highly disparate world,” Bailey said. “The banking world challenges us but it is actually much more homogeneous, so we have to have these tools that say how do these rather disparate and opaque pieces fit together.”
As parts of its efforts to tame risks in the non-bank financial sector — a group that now accounts for roughly half the world’s financial assets — the Bank of England has already announced plans for a liquidity facility that non-banks can access. Bailey called on other central banks around the world to follow suit.
“To avoid a systemic crisis, and reflecting the growth of the non-bank sector, central banks should consider permanent emergency facilities for non-banks,” Bailey said.
The test scenario incorporated many elements from recent market events, including the shock tied to liability-driven investments in 2022. When gilt prices collapsed in the wake of then-Prime Minister Liz Truss’s historic tax-cutting plan, pension fund managers using LDIs faced margin calls.
The central bank ultimately stepped in to stabilize the market.
“We have to have what I call these effective surveillance tools to spot where these problems are and how we deal with them earlier,” Bailey said. “The bedrock of regulation in the non-bank world historically has not been financial stability.”
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