Bank of England orders crackdown on pension funds to prevent repeat of Liz Truss mini-budget crisis
The Bank of England has called for a crackdown on pension funds to avert another crisis like the one triggered by Liz Truss’ mini-budget.
In a report by its Financial Policy Committee (FPC), the central bank said funds holding liability-driven investments (LDIs) should be able to “withstand serious but plausible stresses” in the markets. British public debt.
He suggested the Pensions Regulator introduce a stress test for LDI funds to ensure they could handle a 2.5 percentage point rise in bond yields and demand they hold more cash. to manage daily market movements.
LDIs were used to ensure that pension funds had enough money to meet future payouts while “hedging” themselves against fluctuations in inflation and interest rates.
They were heavily exposed to government securities, and as prices fell, LDI funds had to sell them to raise money for their lenders who demanded more collateral.
Stress tests: The Bank of England said funds holding liability-focused investments should be able to ‘withstand serious but plausible stresses’ in UK government debt markets
This plunged many into crisis and forced the Bank to pump billions into the financial system. The panic began when then-Chancellor Kwasi Kwarteng unveiled £45billion in tax cuts with no mention of spending cuts, raising fears of increased government borrowing.
The FPC said the regulator should take action “as soon as possible” to reduce LDI risks and avoid a repeat.
The Bank also pointed to “vulnerabilities” caused by market finance, sometimes known as “shadow banking”.
Shadow banks are intermediaries that can lend money and take deposits but are not subject to regulatory oversight like normal banks.
These can include hedge funds, private equity funds and mortgage lenders, but also encompass certain activities and products created by regulated banks, such as credit default swaps, which allow an investor to insure against a borrower who defaults on a loan.
The FPC said there was an “urgent need” for resilience in the shadow banking system, noting that vulnerabilities could emerge during market turbulence.
He added that ‘interconnections within the system’ meant that actions taken in certain areas could ‘significantly increase stress across the system as a whole’.
He said action by hedge funds to reduce exposure “has amplified recent volatility in the interest rate market.”
But the Bank confirmed that the UK authorities were “working to reduce vulnerabilities domestically”.
He said Britain’s banking system was “resilient” despite a number of US bank failures and the emergency takeover of Credit Suisse by UBS this month.
The FPC report highlighted that the UK banking system was “well capitalized” and able to support the economy even though economic conditions were “worse than expected”.