The Bank of England is launching its first systemic stress test that aims to examine how banks, insurers, pension funds, hedge funds and retail investment funds behave and interact under a stressed market scenario.
The exercise comes in the wake of recent stress events — such as the onset of the pandemic in March 2020 and turmoil in the U.K. bond market last fall — that revealed a vulnerability to sudden liquidity shocks in the face of rising market volatility.
The central bank said it aims to understand the risks posed by the shadow banking sector (investment funds), how banks and shadow banks behave under stressed conditions, and how these behaviours can interact to amplify shocks in financial markets, impacting financial stability.
“For instance, 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 central bank said in a release.
The exercise — which will focus on the government bond market, repo market, corporate bond markets and related derivative markets — will both inform policymakers’ efforts to address systemic risks in the U.K. and feed into ongoing international policy work.
The BoE also said it will work with the Financial Conduct Authority and the Pensions Regulator to analyze the results of the exercise and develop sector-specific insights. Its final report will be published in 2024.