Bloomberg Audio Studios, podcasts, radio news. So we all know what the MPC is, Monte Policy Committee at the Bank of England. Do you know what the FPC is.
Yeah, Financial Policy Committee, I now know, but I am not surprised that exists.
And they look basically at the financial shocks that institutions could go through and they try and support them in understanding where the risks lie but also how they can help with growth.
Yeah.
I mean, it must be quite an exciting, slash terrifying role to have to imagine the very worst shocks, even worse than we've seen already, that the banking system could endure.
So there was a big report that came out on Friday. We're going to get into the latest report and dig deep to understand what it means for financial institutions and where the big risks lie and why this time it's a little bit different.
Welcome to the City of London, the City of London Bank. We need to mind the gap between the t and the financial hearts of the country.
The city, the city.
Welcome to in the city.
Stand clear of the doors. I'm Francin Laqua, I'm alecro Stratton and this week I look at the recent Financial Stability Report, what it tells us about how prepared finance firms are in times of a crisis. And with us Nat Benjamin, who's appointed Executive Director for Financial Stability, Strategy and Risk, and of course he is also a member of the Financial Policy and Committee. So Nat, thank you and welcome to in the city.
Thank you very much, thank you for having me. It's pleasure to be with you.
Talk to us a little bit about the the FPC.
There's a number of ways in which the Bank of England watches over is to financial stability, and one way of doing it is to ensure that individual institutions within the financial sector are safe and sound. But another way to look at it is to check that the sum of the parts adds up and only focusing on individual
firms is not going to be enough. And that is the focus of the Financial Policy Committee, which is to ensure that the system as a whole, the financial sector as a whole, does its job of ensuring vital services to the real economy, to households and business people's ability to save, to pay, to borrow what they can afford, to invest and to ensure themselves. So that is the focus and systemic risks on the focus of the FBC.
So what do we do while we work to spot them, to track them, and to take action to address them. And every quarter we get together and we see what we think about the key outlook for financial stability at a given juncture. But also we consider our more structural issues with the financial sector, longer term issues, and that is what we did us.
For how do you look at some of the risks out there.
We had quite a lot of things to say last Friday, first the state of the conjuncture at that particular point in time, but also we had published the results of our stress test of the banks. We had done a Desk Bay stress test of the banks to check that were strong enough to support the real economy, both in good times and in bad time. We had also completed and published the result of our systemoid exploratory scenario. So that was quite a pioneering initiative. I don't think it's
been done before, and we're very proud of it. And this is the first time we stressed as the entire financial sector, one part of the financial sector, rather not just just the banks or just the insurance companies. And it's very exciting.
So it was four hundred pages, right, read it all.
And what does it show? I did read it all, but in your own words, what does it show?
So the first thing was just to show the value of such exercises, where instead of just shocking the system and seeing what happens, we don't assume the reaction function of different players in that ecosystem. We do a flow test, so we actually ask them how they would react, and then in the second round we factor that in to see how a shock plays are we impulse a shock on markets that are core to the UK economy and
we see how it plays out. And now what shocks several different markets, different variables, market variables, interest rates, credit variables, very severe stress and in combination is probably more severe than anything we've seen before, including the financial crash, including financial crash, and we apply that to markets that are core to the economy like the guilt market, the guilt repot market, in the sterling corporate bond market and associated interest rates derivatives.
And even in that scenario, that highest stress scenario, worse than the financial crash, did the UK economy start not to it or fall ever?
So what we tested in that system wise exploratory scenario was the resilience of those core markets. And the good news was that market was proved to be more resilience than it was before. That was a positive news. But there's no reason.
For there's always a negative, isn't there.
Exactly, Well, there's no reason for complacency because those things can change fast. So what we need to do is to ensure we look in that improvement in resilience to deal with whatever the future can bring. That is one conclusion. But the other thing we found is that there was a very large redistribution of liquidity across the financial sector between participants, and the other thing we found is that the behavior of market participants amplified the shock, made it worse.
But you're also one that basically hedge funds, right asset managers, and pension providers could be unprepared in times of crisis.
So that is so.
There's a part of the financial system which is much more risky than the rest.
That is the fact that I mean the value of those exercises to put the spotlight on these things in peace time so that everyone gets prepared for when shocks happen. So I'll give you an example what we found is that a number of market participants, for example, hedgephones, we're assuming that if the shock happened, they would be able to get extra repot from their banks. And actually we asked the banks and the bank said, no, there's not
going to be more repo. That's an interesting finding. We've faded back to the hedgehorons participants so that they can factor that in in their own risk management, in their own stress testing.
And I remember being told that, you know, shadow banking was the biggest heart spot when interest rates would go up, but we haven't really seen that much blow up.
Well, if you look back at the last five years, and I think about those last five years as a period of transition away from the post global financial crisis area, which is very unique in many respects, into a new norm. We're transitioning, and there has been bits of turbulence over the last five years. Actually would be a bit bizarre if they hadn't been. But every single time we think about the archae goos, you think about the dash for cash,
you think about the LDI think about Nickel. Every single time the shock was amplified by those vulnerabilities, by margining practices, by the fact that haircuts used to be zero in their ramp up very suddenly and the margin call comes and there's a big margin call and the counterparty scramss around for cash, and that can have a very destabilizing effect on financial stability and especially on the markets on
which those strategies are anchored. So that is why, in particular the international policy work which is aiming at those vulnerabilities is particularly important. And it's important that these things are sorted out in peace time so that you know when the shocks happen, well, there isn't such a ramp up in the size of the calls or the liquidity.
So it sounds like you have a function to sort of teach some practitioners across the city of London, to bring them in and say this is the evidence from our analysis and our exercise, and we suggest you behave differently in future.
Well, you see, this has been a really good aspect of this particular science. It's just the tone of the conversation. It's not an exercise we've done to punish anyone. It's just an exercise to find out what would actually happen. It is not just in the interest of the Bank of England to ensure those markets are resilient. This is in the interest of everyone and of all the participants
because they do business in those markets. And the quality of the ton of the conversation was really good, and we've got really good feedback from the participants because what we've been doing is to be almost maximalist in how much we share back to them from what we learn.
We've talked a lot about how the system might handle the sharks, but let's talk about those sharks. And you keep talking about peace time, but it's actually quite a fraud geopolitical environment right now. When you look at the news, when you look at the developments out of America, out of Europe and so on. These are the kind of shocks you're talking about the system handling, as well as more sort of acutely financial ones, aren't they.
That's right. So, I mean, one of the things we've set out last Friday is that global risks are high, and the uncertainty and the degree of risk around the outlooks has increased, and it matters, particularly because the risk of global fragmentation is higher, and fragmentation is not good for trades, for financial markets, or for international collaboration and cooperation, And there was already pressures on sovereign debts in a
range of advanced economies, and those pressures have increased. So yes, the outlook, the global outlook has become.
Strict, isn't it because you published last week? But in some ways this is a watching brief for all of us knowing exactly what the complexion of the Trump decisions and so on will be. Does that not matter you were did you model, for instance, a tariff regime of x percent on UK exports and imports being affected too.
I mean, this is not about any one country in particular. This is a global phenomenon, and on tariff specifically, It's too early to tell the impacts that tariffs can have. It depends on the reaction function of different jurisdictions. It depends on the actual channels that it takes, whether it causes inflationary pressure, where the impact is on exchange rates, et cetera. And it is not clear keet is not obvious that tariffs in and of themselves might have impacts
on financial stability. Global fragmentation, however, isn't a good thing for financial stability. That is for sure.
We had a big shark in the UK frankly because of pensions under this trust. Could that happen again or have they taken provisions for that to be tamed.
Well.
One of the things we did tests as part of the system WOID exploratory scenario is the guild markets and importing a shop and guild markets, and we had over fifty participants in the exercise, including pension fonds and the LII fonds, and what we saw is that they had built that resilience since the events you describe, and they had higher liquidity buffers, which meant that they were better
able to manage that shock. However, as we discussed earlier, there were other pockets of potential risks that needed to be addressed and managed, and those actions are being taken forward. So it's really important that all these improvements are locked in, as I said, because things can evolve.
Now do you believe that actually a lot of these actors, the hedge funds, the asset managers will look around and say, actually we need to minimize risk.
I think part of the advantages of doing exercise like that where we had great, great engagement from participants like hedge funds and asset managers, is that it puts the spotlight on some of the risks. It put the spotlights on the situation in which actually they might take a loss, and that is something they can then factor in their own internal contingency planning, the risk management and their own
stress testing. So that is an important aspect of it, so that if shocks do happen in the future, their impact is lower and is content.
Can I ask you about regulation, because we're, again, as alluded to, at this juncture where we don't really quite know what the US does. If they deregulate the banks, if they deregulate some of the private companies, some of the private equity, some of the credit companies as well, does that put the UK in a difficult position to decide what to do?
Again, this is not a question but an in one country. But there are calls at the moment for deregulation. You can hear them everywhere. And when I hear that, I cannot fail to just go back in time a little bit and I remember the mid two thousands where there were calls for deregulation and quite frankly, it made our
job more challenging as regulators and supervisors. And then the next thing that happened was the global financial crisis, and that crisis resulted in a considerable loss of growth for many major advanced economies, including the UK, and way beyond the immediate terrible impact for households who are losing their homes, but these things cost a very long shadow over time,
and so I think there's a lesson there. Calls for deregulation may sound very appealing in the short term, but longer term, the people who paid the price for it are the people, the households and the businesses. So it's quite important that we remember those lessons from history as
we look aheat. So, having talked about deregulation and the fact that we need to not forget those lessons in the past, there is a very legitimate question about whether the financial sector is doing enough to support growth generally, and I think that's a very legitimate question to ask, and in particular in areas like payments, innovation, supports for climate transition, finance, or the reform of the pension system.
Those are areas where it's worth asking the question of whether there is more the financial sector can do to support growth.
It's a good question, but it's either you go to the US style, which is free market deregulation, or you force some of the institutions to do some of the things that could eventually help with growth.
I think the idea is to be mindful of those lessons from the past and step into the future, but in a safe way.
How's the interaction between private sector and the bank? Do you feel like you're understand Yeah? Do you feel like you understand each other?
I do so. In my previous job, I was supervising foreign banks in the UK and in the past I was very involved in supervision, so directs bank supervision. There's a good degree of engagement. If I take a step back and I think about and what the UK to be known for as a place to do business, and when I one of the UK regulators to be known for, I want us to be known for the fact that people feel they can talk to us. We're approachable, we can have a conversation. I want us to be known
for actually not kicking up a first for nothing. So when we do have an issue, you know, we say we have an issue, and we're in business and we know what we're talking about, We'll not kicking up a fast for nothing. Will be proportionate and I want us to be known for a place where we're predictable, so we don't spring a surprise on people, and people know what our reaction function is. So those are the type of things I want the UK to be known for.
And I think that enables a really good dialogue. And actually the quality of the dialogue we've had in this system wide exercise has been really good. From that perspective.
We talked about shocks and politics and geopolitics and so on, and your survey shows that's what companies are worried about. They're worried about that. They're worried about cyber risk as well. But just quickly on households, the evidence from I think your report is that households, British households are resilient and they're doing okay. They're absorbing the increase or certainly elevated
mortgage amounts. How long does that last? How long do you think you're confident that they will remain if we have higher interest rates for longer.
I mean, part of the transition we're going through is that it's the real economy going through that transition with a higher interest rates. And overall, as you said, the picture is that it has been challenging time for household but there's been resilient in aggregate. And there's still material proportion of households with mortgage for example, who will have to refinance on higher rate than they have at the moment.
But what we've seen is that for those that have to refinance on higher rate, the average increase in monthly costs to repair their mortgages is lower now than it was projected to be in June, for example. So these things all depends the key of market.
Rates, but still higher.
So there is a wall coming, yeah, but it's a lower wall than it was in the past. And the sense so far there have been resiliently and we don't
see any reason for that not to continue. One thing we have observed we talked about why financial stability matters is so that the financial sector can support household and unlike two thousand and eight, where banks made things worse and amplified the shocks, what we've seen recently is banks supporting household through those difficult times, for example by giving them six months to switch on interest only to repay their mortgages to give them time to absorb the shock,
and then reverting back to full repayment. So those are the type of things that a strong banking system can do to help the economy through a difficult time.
The other shot would be a climate change shock, and I think it used to be a priority. It is not anymore because geo politics and cyber and so on. But I presume you're still looking at it and still feeling that the banks and financial institutions can cope there's a.
Big climate shock, Yeah, definitely. And we also published a refreshed approach to the climate climate risk impact on financials stability. An interesting thing with that is that climate risk is is not just a long term thing. There are also shorter term issues and risk to financial stability coming from climate either from flood example, which affect insurers and reinsurers and also banks to the extent that homes that are subject to flood risk are being the collateral for mortgages.
Another example is from climate transition risk, where some metals are being more more needed for climate transition and there's more pressure on those markets, on those commodities markets, and we've seen over the last few years a few shocks around around those markets, and those impact commodities trading, impact
the derivatives associated. So those are examples of shorter terms financial stability is to climate, and it's important to keep monitoring those things, and we'll be incorporating those things as relevant into the stress test that we do in the future.
Now, I guess the difference is I remember, like ten fifteen years ago, some of these stress tests, you know, felt for me, like a young report at Bloomberg is completely far fetched. It was like interest rates at ten percent, at twelve percent. And now actually a lot of the stress tests seemed to us quite plausible in worst case scenario.
How do you deal with the fact that some of these stress tests could be actually, you know, real life quite yeah, that could actually happen instead of being the far fetched scenarios.
Well, I think we've always sought to, you know, use scenarios for our stress tests that were severe but plausible. And just to give you an example, we've just published the result of our desk based stress test of the banks. We've used two different scenarios mutually incompatible. They can't happen at the same time. One is interest rate going up by a lot, and the other one is interest rate going down by a lot, And we're completely agnostic about which one is more likely than the other one, which
just apply those two scenarios and see what happens. So that is part of what we do to deal with what you just said, is to be more exploratory in our nature, so that we don't have to speculate on what might happen. If it happens, what's the consequence.
Nott, Thank you so much for joining us. That was great, really interesting, very well explained.
Thanks for listening to this bonus episode of In the City from Bloomberg. It was hosted by me Alekri Stratton and Francine Laqua. It was produced by Samasadi, production support from Moses and Dam and sound designed by Blake Maples. Brendan Francis Newnham is our executive producer. Sage Bauman is Head of Podcasts Special thanks to Nathaniel Benjamin. Please subscribe, rate, and review wherever you listen to podcasts.