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    UK Agencies Examine Financial Stability Outlook

    July 13, 2021

    The Bank of England (BoE) published the financial stability report, which sets out views of the Financial Policy Committee (FPC) on stability of the financial system and details interim results of the 2021 solvency stress tests on banks. The results indicate that the banking sector remains well-capitalized and resilient. The full and final results of the 2021 solvency stress test, including bank-specific outcomes, will be published in the fourth quarter of 2021. Along with the financial stability report, BoE published a summary and record of the July 2021 meeting of FPC, which aims to identify risks to financial stability and agree on policy actions aimed at safeguarding the resilience of the UK financial system. The Prudential Regulation Authority (PRA) also announced that the extraordinary guardrails within which it asked bank boards to determine the appropriate level of distributions in relation to the full-year 2020 results are no longer necessary and have been removed with immediate effect.

    FPC supports the decision that extraordinary guardrails on shareholder distributions are no longer necessary, consistent with the return to the standard approach of PRA to capital-setting and shareholder distributions through 2021. Furthermore, FPC expects to maintain the UK countercyclical capital buffer rate at 0% until at least December 2021. Due to the usual twelve-month implementation lag, any subsequent increase would therefore not be expected to take effect until the end of 2022 at the earliest. At the meeting, FPC identified key focus areas to reduce the likelihood and impact of disruptions to market‐based finance; these focus areas include reducing the demand from the non‐bank financial system for liquidity in stress, ensuring the resilience of the supply of liquidity in stress, and potential additional central bank liquidity backstops for market functioning. FPC also supports the international work to assess whether there was more procyclicality in margin calls than was warranted, whether market participants were prepared for margin calls in a stress, and any consequent need for policy in light of this, without compromising the benefits of the post‐global financial crisis margining reforms. For central banks to deal effectively with financial instability caused by market dysfunction, FPC supports examining whether any new tools are needed; the tools would need to be both effective and minimize any incentives for excessive risk‐taking in the future through appropriate pricing and accompanying regulatory requirements. 

    In another development, BoE and the Financial Conduct Authority (FCA) concluded their joint review into risks in open‐ended funds and have developed a possible framework for liquidity classification and swing pricing. FPC recognizes that further work is needed to consider how these principles could be applied, and a number of operational challenges will need to be addressed before any final policy is designed and implemented. FPC emphasizes that market participants should use the most robust alternative benchmarks available in transitioning away from use of LIBOR to minimize future risks to financial stability. FPC believes that the recently created credit-sensitive rates—such as those being used in some USD markets—are not robust or suitable for widespread use as a benchmark and considers these rates to have the potential to reintroduce many of the financial stability risks associated with LIBOR. With respect to addressing risks associated wit cloud services, FPC is of the view that additional policy measures to mitigate financial stability risks in this area are needed and welcomes the engagement among BoE, FCA, and Her Majesty's Treasury on how to tackle these risks. FPC has already highlighted that the market for cloud services is highly concentrated among a few cloud service providers, which could pose risks to financial stability. 

     

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    Keywords: Europe, UK, Banking, Securities, COVID-19, Dividend Distribution, Stress Testing, CCyB, Regulatory Capital, Credit Risk, Liquidity Risk, LIBOR, Interest Rate Benchmarks, Cloud Service Providers, Cloud Computing, Financial Stability, Benchmark Reform, Basel, PRA, FPC, FCA

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