The Bank of England (BofE) has launched its first system-wide exploratory scenario (SWES) exercise, aimed at improving understanding of the behaviours of banks and non-bank financial institutions (NBFI) in stressed financial market conditions.

Participating firms will include large banks, insurers, central counterparties and a variety of funds, including pension funds, hedge funds, and funds managed by asset managers, as reflection of the wide range of institutions engaged in UK financial markets.

The markets of focus, meanwhile, include the gilt market, gilt repo market, sterling corporate bond market and associated derivative markets.

Announcing the exercise, the BofE suggested that recent events have shown that market-based finance has been increasingly prone to sudden liquidity stresses during periods of market volatility, highlighting the adverse gilt dynamics seen in September 2022, which required BofE intervention, as an example of this.

The exercise therefore aims to enhance understanding of the risks to and from NBFIs, and the behaviour of NBFIs and banks in stress, as well as how these behaviours and market dynamics can amplify shocks in markets and potentially bring about risks to UK financial stability.

As part of the initiative, participants will be asked to evaluate the impact of a "severe but plausible" stress to global financial markets, and consider what actions they would take in response to the scenario, with a focus on behaviours in UK financial markets.

The BofE will then seek to understand the collective actions and responses of these firms and how they might amplify the initial stress in UK financial markets.

For instance, the BofE suggested that if a common response to the scenario is for participants to sell the same asset, then fire sale-type dynamics may occur, which can only be understood by taking a system-wide perspective.

The BofE said it will be working closely with the Financial Conduct Authority and The Pensions Regulator (TPR) on the initiative, bringing together data and information from various parts of the financial system to develop system-wide and sector-specific insights.

However, the BofE clarified that the exercise is not a test of the resilience of the individual firms participating, confirming that any materials will not provide information on any individual firms.

The full list of participants and details of the stress scenario will be published "later in the year", with a final report, including the system-wide findings and implications for the SWES markets of focus, to be published in 2024.

Commenting on the exercise, BofE deputy governor for financial stability, Jon Cunliffe, stated: “We regularly run scenario exercises with a variety of firms which support our efforts to protect and enhance the stability of the UK financial system.

"The launch of this exercise will provide valuable insight into the system-wide dynamics for banks and non-banks following a severe but plausible stress to financial markets.”

Adding to this TPR chief executive, Nausicaa Delfas, said: “We are pleased to be working alongside the Bank of England and Financial Conduct Authority on this important system-wide exercise.”

Share Story: