Maintaining the smooth circulation of funds within the dynamic international marketplace
In a recent development, the Bank of England has outlined key principles for the new funding and liquidity landscape, taking into account the rising importance of non-bank financial institutions (NBFIs) and the evolving monetary policy environment.
The shift away from ultra-low interest rates and large central bank balance sheets has impacted liquidity flows, necessitating a new funding environment that accounts for monetary policy changes and the growing role of market-based finance, including NBFIs.
NBFIs, which account for around half of assets in the financial system, both globally and in the UK, play a critical role in providing liquidity and depth in the gilt market, serving as a risk-free benchmark for sterling-denominated debt. However, unlike banks, they cannot hold central bank reserves or create money through deposits.
Recognizing the distinct liquidity needs of NBFIs, the Bank of England aims to create a funding and liquidity environment that incentivizes banks and NBFIs to participate actively in private sector funding markets. Banks are encouraged to take into account their ability to use the Bank of England's lending facilities regularly for routine liquidity management.
The primary responsibility for managing liquidity risks lies with financial institutions themselves, including banks and NBFIs. The Bank of England encourages the efficient distribution, or recycling, of liquidity across the financial system to support the continued provision of financial services by NBFIs in a way that avoids unsustainable risk-taking and leverage.
To manage systemic risks, transparency about NBFI activities should be improved, and vulnerabilities such as susceptibility to runs in money market funds (MMFs) addressed, thus mitigating risks spilling over between the banking and NBFI sectors.
Flexibility and tailoring of funding solutions are also important considerations. For businesses and NBFIs alike, adapting to the new landscape involves leveraging more flexible and tailored funding options, such as private equity with operational support, recognizing the diverse profiles and risk appetites of entities within the sector.
Given that NBFIs include various subsectors like investment funds (60%), insurance companies, and pension funds, ongoing supervision of leverage levels and risk-taking within these subsectors is important for systemic resilience.
Nathanaël Benjamin, Executive Director of Financial Stability Strategy at the Bank of England, emphasized that the new principles emphasize a holistic approach that incorporates the complexities of monetary policy normalization, the distinctive structural features of NBFIs, and the need for prudential safeguards to maintain liquidity flow and financial stability in a more market-based and interconnected financial system.
The Bank of England's overarching goal is to deliver monetary and financial stability, with a focus on ensuring the continued provision of financial services by NBFIs without fostering excessive leverage or risky behavior, aligning incentives to promote prudent risk management within the sector. The aim is to ensure that liquidity can flow around the financial system to get where it is needed most, enabling the financial system to self-manage increased liquidity demands and absorb shocks during plausible stress scenarios.
In conclusion, the new principles outline a comprehensive approach that seeks to maintain financial stability in the face of changing monetary policy and the growing role of NBFIs in the financial system. Market participants, including NBFIs, should maintain their own liquidity resilience to allow self-stabilization in response to shocks, while the Bank of England continues to play a significant role in providing liquidity to NBFIs and ensuring the efficient distribution of liquidity across the financial system.
- The Bank of England's new funding and liquidity principles acknowledge the significance of non-bank financial institutions (NBFIs) in the evolving monetary policy environment.
- Recognizing the growing role of market-based finance, including NBFIs, the shift away from traditional funding methods requires a sustainable approach to AI, data, and personal-finance management in the industry.
- As key players in the financial system, NBFIs, such as investment funds, insurance companies, and pension funds, should adhere to prudential safeguards to maintain liquidity flow and financial stability.
- To promote efficient liquidity distribution, the Bank of England encourages active participation from banks and NBFIs in private sector funding markets.
- The integrated use of insights, AI, and wealth management could help financial institutions make informed decisions in the face of systemic risks, ensuring risk mitigation and sustainable growth in the banking-and-insurance sector.
- The ongoing supervision of leverage levels and risk-taking within various NBFI subsectors is crucial for systemic resilience and the prevention of unsustainable risk-taking and leverage.
- The new principles prioritize maintaining financial stability through a holistic approach that considers monetary policy normalization, the complexities of NBFIs, and the importance of prudential safeguards in a more market-based and interconnected financial system.
