Bank of England launches new stress test for lenders

The Bank of England has launched its first system-wide exploratory scenario (SWES) exercise, which aims to improve understanding of the behaviours of banks and non-bank financial institutions (NBFIs) in stressed financial market conditions.

The exercise will explore how those behaviours might interact to amplify shocks in UK financial markets.

Participating firms will include large banks, insurers, central counterparties and a variety of funds (pension funds, hedge funds, and funds managed by asset managers). Participants will be actively engaged in both the design and execution of the exercise.

The Bank says recent events have shown that market-based finance (MBF) has been increasingly prone to sudden liquidity stresses during periods of market volatility, citing the March 2020 ‘dash for cash’ and the adverse gilt dynamics seen in September 2022, which required Bank intervention.

Participants will be asked to evaluate the impact of a severe but plausible stress to global financial markets, and consider what actions they would take in response to the scenario, with a focus on behaviours in UK financial markets.

The Bank will then look at the collective actions and responses of these firms and how they might amplify the initial stress in UK financial markets. For instance, if a common response to the scenario is for participants to sell the same asset, then fire sale-type dynamics may occur.

The Bank says the exercise will improve its understanding of how markets operate under stress, support efforts to address vulnerabilities in system and help in contributions to ongoing international policy work.

The Bank will publish the full list of participants and details of the stress scenario later in the year and the final report will be published in 2024.

Jon Cunliffe, deputy governor for financial stability at the Bank of England, said: “We regularly run scenario exercises with a variety of firms which support our efforts to protect and enhance the stability of the UK financial system. The launch of this exercise will provide valuable insight into the system-wide dynamics for banks and non-banks following a severe but plausible stress to financial markets.”