BoE Publishes Financial Stability Report in July 2019

The report highlights that the core of UK financial system, including banks, dealers, and insurance companies, is resilient to, and prepared for, the wide range of risks it could face, including a worst-case disorderly Brexit. FPC is maintaining the UK countercyclical capital buffer (CCyB) rate at 1%. The report specifies that most financial stability risks stemming from disruption to cross-border financial services in a no-deal Brexit have been mitigated. However, in the absence of further action by EU authorities, some disruption to cross-border financial services is possible. Although such disruption would primarily affect EU households and businesses, it could amplify volatility and spill back to the UK in ways that cannot be fully anticipated or mitigated.

BoE will, in 2019, conduct a biennial exploratory exercise to explore the implications of a severe and broad-based liquidity stress affecting major UK banks simultaneously. Banks hold regulatory liquidity buffers that FPC expects to be used in a stress. The exercise will explore how the reactions of banks and authorities to the stress would shape its impact on the broader financial system and the UK economy. BoE intends to publish the results of the exploratory exercise in mid-2020. The report notes that in the 2021 biennial exploratory scenario, BoE will stress test resilience of the financial system to the physical and transition risks of climate change. It will gather views on the design of the exercise and, as a first step, will publish a discussion paper in Autumn 2019. This exercise will integrate climate scenarios with macroeconomic and financial system models. This will also motivate firms to address data gaps and to develop cutting-edge risk management consistent with a range of possible climate pathways—ranging from early and orderly to late and disruptive. The discussion paper will cover issues such as the coverage of the test, the nature of scenarios considered, and the appropriate time horizon and disclosure of results. 

The report mentions that continued reliance of global financial markets on LIBOR poses risks to financial stability that can be reduced only through a transition to alternative benchmark rates by the end of 2021. The pace of market participants’ transition efforts now needs to accelerate and FPC will monitor the progress closely. The smoothest transition will be one in which market participants cease new issuance of LIBOR-linked contracts; identify all existing contracts without appropriate fallback clauses and rectify this to the greatest extent possible; and actively reduce legacy exposures by negotiating their transition to new rates. It is not in firms’ own interests to have a large stock of legacy contracts that will become subject to significant legal uncertainty beyond 2021. There are advantages to re-negotiating contracts to refer to alternative reference rates well in advance of the end of 2021. Well-managed firms are expected to lead the transition. All firms that responded to the PRA’s and FCA’s Dear CEO letter have now appointed a Senior Manager accountable for overseeing the transition.

Related Links

• Notification
• Financial Stability Report (PDF)
• Record of FPC Meeting (PDF)

Keywords: Europe, UK, Banking, Insurance, Securities, Financial Stability Board, Brexit, CCyB, LIBOR, Stress Testing, Systemic Risk, Climate Change Risks, FPC, BoE