Participants will have to disclose how actions potentially undermine the financial system, particularly banks and pension funds.
After being invited to participate in the the first-ever stress tests including the shadow banking industry, many of the biggest hedge funds in the world will report whether their investment strategies run the danger of magnifying economic shocks and undermining the banking system in the United Kingdom.
Over fifty City institutions have signed up to participate in the movement, which will assess how banking and non-bank financial entities, also known as the unregulated banking sector, affect financial stability.
Large banks like HSBC, Goldman Sachs, JP Morgan, and Merrill are on the list, as are insurers like Aviva and Legal & General, clearinghouses like Brevan Howard, Citadel, the Millennium The capital Partners, Rokos Capital Management, and Capula Investment Management, as well as asset managers, pension funds, and hedge funds.
It occurs at a time when worries regarding the functioning of the shadows banking sector, which has grown by double since the financial crisis of 2007–2008 and accounts for roughly half of all corporate loans globally but is not subject to the same rigorous regulation as ordinary banks, are on the rise.
The undercover banking exercise is intended to assist regulators in understanding how the firms react to each other during a market downturn and how their combined actions could “amplify impacts in the United Kingdom securities markets that are fundamental to UK financial security,” as opposed to bank sector stress tests, which gauge the resiliency of individual firms.
“Given that marketplace-based finance plays a growing part in supporting the economy as a whole, significant market failure can, for instance amount to a tightness of credit terms which may decrease the availability of financing to consumers and to businesses,” the Bank of England said.
The two-phase exam will first demonstrate how businesses would react to a fictitious economic shock before presenting a second scenario based on the actions of the group as a whole and asking how businesses would respond to that increased level of financial stress.
Along with the Financial Conduct Agency and the Pensions Regulator, the Prudential Regulation Authority of the Bank of England is conducting the study. It expects to disclose its results in 2024, ten years after traditional financial institutions first came under comparable examination in 2014.
The recent cash crunch at the beginning of the epidemic in 2020—which saw investors quickly withdraw their money—illustrated the potential hazards posed by shadow banking.
The Bank also cited the UK’s retirement savings crisis in September 2022, which had its origins in the government’s terrible mini-budget but resulted in a record-breaking decline in UK bond prices. The Bank of England was ultimately compelled by market panic to intervene with £65 billion in emergency liquidity to support the bond marketplace and prevent problems from spreading to other areas of the financial industry.