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Bank of England to Conduct Second Leg of System-Wide Stress Test, Assessing Response to Interest Rates and Risky Asset Price Shocks

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The Bank of England (BoE) has announced that it will commence the second phase of its system-wide stress test to evaluate how banks, insurers, pension schemes, and clearing houses respond to shocks involving interest rates and risky asset prices. The stress test, known as the system-wide exploratory scenario (SWES), aims to assess the resilience of the financial sector during severe, wide-ranging, and persistent conditions.

In June, the BoE launched its first sector-wide stress test by gathering information from over 50 firms. Now, the central bank has provided further details on the test, which will examine scenarios more challenging than the economic downturn caused by the pandemic and the liability-driven investment crisis experienced last year.

The SWES will run for a period of ten days, during which the BoE will study how market players handle significant demands for liquidity, such as meeting additional margin calls within a short timeframe. The results of the stress test will be published in an SWES findings report by the end of 2024, with no individual firm being assigned a “pass” or “fail” grade.

To ensure a comprehensive assessment, the BoE has consulted with international regulators, including the Federal Reserve, the European Central Bank, and regulatory authorities in Dublin and Luxembourg, where many British funds are listed. The central bank aims to understand how non-bank financial institutions manage liquidity requirements in response to the hypothetical scenario presented in the stress test.

The SWES findings will play a crucial role in shaping international regulatory policies, as regulators globally focus on the non-bank sector, which now accounts for approximately half of the global financial sector. The Federal Reserve previously provided liquidity support to money market funds in 2020, while the BoE intervened by purchasing government bonds to alleviate liquidity strain in liability-driven investment funds last autumn. By analyzing the responses of market players in stress test scenarios, the BoE aims to reduce the likelihood of central bank interventions during future market crises.

The results of the stress test will aid in the development of more robust regulatory frameworks, ensuring the financial sector’s stability and resilience in the face of potential shocks. The SWES findings will offer valuable insights to policymakers worldwide, helping to mitigate risks and protect the global financial system.

More detail via Kitco.com here… ( Image via Kitco.com )

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