Bank of England Urges Proactive Regulation of Non-Bank Sector

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The Bank of England (BoE) emphasizes the necessity for broader regulatory oversight of financial institutions beyond traditional banks to avert potential crises in the non-bank sector, which could lead to a credit crunch and significant economic disruption.

Following Prime Minister Liz Truss’s announcement of unfunded tax cuts in September 2022, the BoE intervened by purchasing UK government bonds as yields surged, causing liability-driven investment (LDI) funds to scramble for additional collateral.

This episode underscored the importance of shedding light on “non-banks,” including insurers, pension schemes, asset managers, and funds, which constitute approximately half of global financial assets. Despite their substantial presence, these entities face less regulation compared to traditional lenders, especially concerning credit provision.

The BoE has initiated a stress test to gather data on the connections between banks and the non-bank financial intermediation (NBFI) sector. The aim is to persuade international regulators, particularly securities watchdogs, to collaborate on regulatory measures.

BoE Deputy Governor Sarah Breeden stresses the need for further research to identify data gaps and enhance resilience in the sector, which has been a key contributor to the £425 billion ($539 billion) net increase in UK business lending since 2008.

Breeden emphasizes the importance of proactive policy action on NBFI to preempt crises before they materialize, as the non-bank sector has the potential to trigger a credit crunch.

Claudio Borio, head of the monetary and economic department at the Bank for International Settlements, highlights unresolved fragilities in non-banks and emphasizes the necessity for a regulatory framework that includes financial stability in securities regulators’ mandates.

The BoE proposes tougher liquidity guidelines for LDI funds and money market funds. However, effective implementation requires parallel action from the EU, as many funds are listed there.

The U.S. Treasury-led Financial Stability Oversight Council has agreed to enhance oversight of non-banks, eliciting resistance from large funds wary of bank-like regulations.

Meanwhile, the G20’s Financial Stability Board is pursuing a comprehensive work program to bolster non-bank liquidity resilience, with a progress report slated for July.