The Bank of England (BoE) has unveiled its plan for the second phase of its inaugural system-wide stress test, focusing on how various financial entities, including banks, insurers, pension schemes, and clearing houses, collectively respond to shocks related to interest rates and risky asset prices over a 10-day period.
This follows the BoE’s announcement in June of its first-ever sector-wide stress test, known as the System-Wide Exploratory Scenario (SWES), which began with data collection from more than 50 financial firms.
In its recent announcement, the BoE provided further insights into the stress test, indicating that the scenarios to be evaluated will be more severe, comprehensive, and long-lasting than events like the “dash for cash” observed in March 2020 during the pandemic lockdowns or the UK government bond crisis in September to October of the same year.
The BoE stated its intention to carry out a second round of scenario testing through 2024 and aims to publish the final SWES report by the end of that year.
Importantly, the stress test will not assign a “pass” or “fail” status to individual firms, emphasizing a broader evaluation of the industry’s resilience.
The BoE has collaborated with international regulators, including the Federal Reserve, the European Central Bank, and regulatory bodies in Dublin and Luxembourg, where many British funds are listed, to ensure a comprehensive assessment.
One of the key objectives of the stress test is to assess how financial market participants handle substantial liquidity demands, such as meeting margin calls on positions within a short timeframe.
For non-bank financial institutions, the focus will be on analyzing how their liquidity requirements evolve in response to the hypothetical scenario and the actions they take to address them.
Globally, regulators have been scrutinizing the non-bank sector, which now constitutes approximately half of the global financial sector, with particular attention to mitigating the risks associated with this sector.
The BoE’s move is in line with these efforts and is aimed at preventing central bank interventions, like the provision of liquidity during market crises, as witnessed in 2020.
In summary, the Bank of England’s announcement marks the initiation of the second phase of its groundbreaking system-wide stress test, which will assess the financial industry’s resilience to severe shocks.
The results are expected to inform international regulatory policymaking and contribute to a more robust and resilient financial system in the face of future market challenges.