Featured Product

    BoE Paper Examines Impact of Systemwide Stress on Market-Based Finance

    July 12, 2019

    BoE published a working paper that presents a model for assessing the behavior of market-based finance in UK under system-wide stress. The core of this model is a set of representative agents, which correspond to key sectors of the financial system in UK. These agents interact in asset, funding (repo), and derivatives markets and face a range of solvency and liquidity constraints on their behavior.

    Market-based finance has been an increasingly important source of credit to the real economy since the financial crisis. The working paper describes characteristics of the market-based finance sector in UK, also presenting details of the assessment model, data used to parameterise the model, and results from the model. The model generates "tipping points" such that, if shocks are large, or if headroom relative to constraints is small, lower asset prices can cause solvency/liquidity constraints to bind, resulting in forced deleveraging and large endogenous illiquidity premia. The findings highlight the key role played by broker-dealers, commercial banks, investment funds, and life insurers in shaping these dynamics. 

    The model can generate an adverse feedback loop in which lower asset prices cause solvency/liquidity constraints to bind, leading intermediaries to pull funding, greater deleveraging, pushing asset prices lower still. This feedback loop has been illustrated via a stress scenario in which a deteriorating corporate sector outlook coincides with heightened redemptions from investment funds and tighter leverage limits at key intermediaries. This scenario highlights the potential interplay between solvency and liquidity constraints in shaping the response of asset prices in the model. The result notes that the reaction of a broker-dealers, which pulls significant reverse repo provision to "downstream" investors to meet its leverage limit, amplifies the shock substantially. Similarly, the behavior of the commercial bank intensifies the funding squeeze further. The results point to the solvency position of a life insurer as the key tipping point for the system. The authors of the paper suggest several avenues for future research. There may be value in using insights from this model to build summary indicators of the resilience of the system. One such indicator might involve keeping track of the stock of "unlevered" funding that might support market prices in an actual stress event.

     

    Related Links

    Keywords: Europe, UK, Banking, Insurance, Securities, Stress Testing, Market-Based Finance, Solvency and Liquidity Constraints, Repo, Systemic Risk, BoE

    Featured Experts
    Related Articles
    News

    Regulators Fine Goldman Sachs for Risk Management Failures

    FCA and PRA in the UK, FED in the US, and the authorities in Singapore have fined Goldman Sachs for risk management failures in connection with the 1Malaysia Development Berhad (1MDB).

    October 23, 2020 WebPage Regulatory News
    News

    Canada Hosts International Conference of Banking Supervisors

    BCBS announced that OSFI and the Bank of Canada hosted the 21st International Conference of Banking Supervisors (ICBS) virtually on October 19-22, 2020.

    October 22, 2020 WebPage Regulatory News
    News

    FCA Proposes More Measures to Help Insurance Customers Amid Crisis

    FCA proposed guidance on how firms should continue to seek to help customers who hold insurance and premium finance products and may be in financial difficulty because of COVID-19, after October 31, 2020.

    October 21, 2020 WebPage Regulatory News
    News

    EBA Issues Opinion to Address Risk Stemming from Legacy Instruments

    EBA issued an opinion on prudential treatment of the legacy instruments as the grandfathering period nears an end on December 31, 2021.

    October 21, 2020 WebPage Regulatory News
    News

    ESRB Publishes Non-Bank Financial Intermediation Risk Monitor for 2020

    ESRB published the fifth issue of the EU Non-bank Financial Intermediation Risk Monitor 2020 (NBFI Monitor).

    October 21, 2020 WebPage Regulatory News
    News

    HM Treasury Publishes Policy Statement Amending Benchmarks Regulation

    HM Treasury announced that the new Financial Services Bill has been introduced in the Parliament.

    October 21, 2020 WebPage Regulatory News
    News

    APRA Initiates Action Against a Bank for Liquidity Compliance Breach

    APRA announced that it has increased the minimum liquidity requirement of Bendigo and Adelaide Bank for failing to comply with the prudential standard on liquidity.

    October 21, 2020 WebPage Regulatory News
    News

    PRA Consults on Implementation of Certain Provisions of CRD5 and CRR2

    PRA published the consultation paper CP17/20 to propose changes to certain rules, supervisory statements, and statements of policy to implement elements of the Capital Requirements Directive (CRD5).

    October 20, 2020 WebPage Regulatory News
    News

    US Agencies Finalize Rule to Reduce Impact of Large Bank Failures

    US Agencies adopted a final rule that applies to advanced approaches banking organizations and aims to reduce interconnectedness in the financial system as well as to reduce contagion risks associated with the failure of a global systemically important bank (G-SIB).

    October 20, 2020 WebPage Regulatory News
    News

    US Agencies Finalize Rule on Net Stable Funding Ratio Requirements

    US Agencies (FDIC, FED, and OCC) adopted a final rule that implements the net stable funding ratio (NSFR) for certain large banking organizations.

    October 20, 2020 WebPage Regulatory News
    RESULTS 1 - 10 OF 6004