The Bank of England (BoE) has announced plans to establish its first lending facility for insurers and pension funds in order to prevent a repeat of last year’s bond market turmoil. Andrew Hauser, the BoE’s executive director for markets, stated that although the central bank has various tools to lend to banks during times of market stress, there is currently no equivalent for non-bank financial institutions (NBFIs). As a result, the BoE was forced to implement one-off measures in response to former Prime Minister Liz Truss’ “mini-budget” and the onset of the COVID-19 pandemic in 2020.
Hauser revealed the BoE’s intention to design a new lending facility for insurance companies and pension funds, including newly-resilient Liability-Driven Investment (LDI) funds. These financial institutions hold significant amounts of British government bonds, which usually can be easily exchanged for cash. However, during periods of market turmoil, shortages of buyers can arise.
Hauser emphasized the necessity of this new facility, citing the introduction of systemic risks by NBFIs and the current incompleteness of the BoE’s toolkit. Globally, NBFIs, often referred to as “shadow banks” and including investment firms like hedge funds, represent around half of the financial sector and have experienced rapid growth since the 2008 financial crisis.
Historically, lending to banks during crises did not always reach NBFIs facing liquidity issues, and directly buying and selling assets posed financial and policy risks for the BoE. To address this, the BoE purchased £19.3 billion ($23.5 billion) of long-dated and inflation-linked gilts from LDI funds used by pension providers last year, following a slump in bond prices triggered by Truss’ mini-budget. These bonds have since been sold back to the market at a profit. However, this move coincided with inflation reaching an 11.1% high, leading to a delay in the commencement of active bond sales from the BoE’s separate quantitative easing portfolio.
Hauser outlined the BoE’s intention to eventually expand the lending facility to a broader range of non-banks. Nevertheless, he cautioned that the program is not designed to reduce financial firms’ responsibility to protect against everyday risks. He emphasized that while it is the role of central banks to safeguard the system against genuine threats to stability, it is the responsibility of firms to shield themselves against a wide array of less severe shocks.
Globally and in the UK, regulators are already considering tighter liquidity rules for non-banks to enhance their ability to cope with market shocks and minimize their reliance on central bank assistance. Nonetheless, designing a suitable facility for insurers and pension funds poses challenges due to the large number of potentially eligible firms compared to the limited coverage of existing BoE lending facilities, which currently serves fewer than 230 banks.
Establishing a lending facility for these non-bank financial firms may also encounter legal hurdles, and many firms may lack the internal capacity to manage the associated financial risks. Despite these challenges, the BoE is determined to address the systemic risks posed by NBFIs and ensure a more stable financial landscape.