Bank of England governor Andrew Bailey has warned Rishi Sunak’s government against going too far with its flagship programme to free the City from post-crisis regulations, insisting that the rules remain essential more than a decade after the crash.
Bailey’s intervention came as the central bank said it would carry out the world’s first stress tests on non-bank financial markets, after September’s implosion of UK pension funds revealed systemic risks that caught policymakers off guard.
“The notion that we’re past the financial crisis and we therefore don’t need the regulation that we had post the financial crisis, I would not go along with that,” Bailey said.
His comments came just days after chancellor Jeremy Hunt announced the biggest shake up of UK financial regulation in decades, while insisting that the reforms were being carried out “very, very carefully”.
The UK government hopes a liberalised financial regulation regime will reinvigorate the City after Brexit. But the Bank argues strong rules boost the financial sector’s competitiveness and manage risk more effectively than before the crisis.
Bailey said it was “important to make clear, that the basis on which the regulatory [regime] was done was not done just to address a particular problem that then went away”. He added: “It was done to put down some pretty fundamental planks of the regulatory system.”
The government’s plans, dubbed the “Edinburgh reforms”, include relaxing ringfencing rules around the separation of retail and investment banking and simplifying rules for parts of the investment market.
There will be a review of the “senior managers regime”, designed to hold executives to account for infractions on their watch, while the UK’s top regulators — including the BoE — will have a mandate to boost the City’s competitiveness.
Hunt insists the reforms are not the bonfire of regulations some hoped for after Brexit, and told the FT’s Global Boardroom conference last week his plans were a “considered and balanced package”.
“We have to make sure we don’t unlearn the lessons of 2008 but at the same time recognise that banks today have much stronger balance sheets,” the chancellor said.
Hunt’s allies said on Tuesday that there were no differences on policy between the chancellor and BoE governor.
Bailey said Brexit gave the UK the opportunity to tweak some outdated rules as well as those ill-suited to the UK, such as for capital requirements for insurers.
But he hinted at a potential clash with the government over its plans to redraw the senior managers regime, whose benefits he defended. The 2016 regime, which bankers once claimed made them “terrified”, sets personal accountability standards so that executives as well as institutions are held responsible for crises.
“[The senior managers’ regime] moved us from a world where the judgment was one of culpability to one of responsibility,” the governor said. “That has created a helpful dynamic.”
In its regular financial stability update, the BoE said on Tuesday that post-crisis reforms also contributed to what it termed a “robust” UK bank sector with high levels of capital. It added that both banks and the UK’s corporate sectors were now well positioned to withstand the country’s worsening economic outlook.
The Bank said that, while UK households were being “stretched” by rising interest rates and soaring inflation, they were not yet showing “widespread signs of financial difficulties” or an inability to repay loans.
But the BoE’s Financial Policy Committee — made up of senior bank officials and external experts — expressed greater concern about the non-banking financial sector and called for “urgent” international action.
“We’ve had a whole series of non-bank incidents across different jurisdictions and I think it is absolutely critical . . . to recognise this is a sector that is highly internationally diversified [and needs global rules],” said Bailey.
Non-bank financial institutions’ share of the global financial services market has more than doubled since the 2007-08 financial crisis.
In its planned stress tests, BoE is planning a “deep dive into specific risks” in markets dominated by institutions such as hedge funds, mutual funds and pension funds so that policymakers can “propose solutions”. But, unlike its banking stress tests, it will not publish results for individual institutions or order actions such as raising capital or withholding dividends.
The tests will look at issues such as how a shock in one financial market can ripple through another, the dangers of highly concentrated risks and how behaviours evolve through a crisis, with further details to be revealed in the first half of 2023.
Those areas were noted as weak points by the BoE after September’s liability-driven investment crisis, when a surge in UK government bond yields led to a rapid sale of gilts by pension funds in the wake of then prime minister Liz Truss’s poorly received “mini” Budget.
The central bank also identified “deficiencies” in how banks, which were involved in LDI derivative trades, “monitor and manage risks”, as well as “a lack of regular and granular data”.
The BoE ultimately had to step in with an £65bn bond-buying programme to stabilise UK government bond markets.
Jon Cunliffe, deputy governor for financial stability, said that while the BoE did not have powers to supervise some non-banks, it could request such powers at a later stage and could make “pretty strong recommendations”.
The central bank is separately calling for more stringent oversight of LDIs. On Tuesday, it asked regulators in Ireland and Luxembourg, which oversee most of the UK pension industry’s LDI funds, and The Pensions Regulator, which monitors the pension funds themselves, to set out a permanent safety net that funds should maintain to withstand shocks.