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Bank of England officials are pushing to double the amount of easily sellable assets that money market funds have to hold, the latest move by financial watchdogs globally to reduce shadow banking risks.
The BoE’s financial stability experts recommended the tighter liquidity requirements for the £250bn of sterling money market funds as they cited risks including geopolitical tensions and “stretched” valuations in some markets.
“The overall risk environment remains challenging,” the BoE’s quarterly financial stability statement said on Tuesday. It also cited rising household indebtedness and the tripling prevalence of 35-year plus mortgages in the UK since 2021.
Shadow banks, which span a broad sweep of the financial sector including hedge funds to insurers to non-bank lenders, have been at the centre of a spate of recent crises, including the dash for cash in March 2020 when markets seized up as the pandemic hit and the UK gilts crisis in late 2022.
The statement on Tuesday was the latest in a series of measures aimed at reducing risk in various areas of the shadow banking sector.
The UK has already imposed higher liquidity standards on liability-driven investment vehicles used by pension funds. The leveraged vehicles exacerbated the 2022 gilts crisis through a mass sell-off of bonds in the aftermath of Liz Truss’s “mini” Budget.
Under the recommendations, money market funds would have to hold up 50 to 60 per cent of their funds in assets that can be liquidated within seven days.
The current requirement is 30 per cent, though the industry average is about 45 to 50 per cent. Sterling denominated money market funds have £250bn of assets, though much of this is held in the EU.
The BoE stressed the importance of international co-ordination around measures to reduce risk in the funds industry.
The Financial Conduct Authority, which supervises money market funds, and the Treasury will consult on the UK’s requirements later this year. The US has already announced a weekly liquidity requirement of 50 per cent.
The BoE’s financial stability experts also announced an overhaul of next year’s banking stress test to better capture the risks from a prolonged era of high interest rates after more than a decade of loose monetary policy.
The bank stress tests are an annual exercise introduced in the aftermath of the financial crisis to ensure lenders were well prepared for potential crises.
The central bank announced that it will run an in-house exercise in 2024 testing against a range of shocks. Results will be published for the system as a whole.
The BoE usually asks eight named banks to run their own stress tests against a single scenario and publishes each bank’s results individually. It plans to return to that structure from 2025.
The statement on Tuesday separately noted that hedge funds continued to have “material leveraged positions in US Treasuries” and said it would “continue to monitor risks to core market function and broader financial stability posed by leveraged trades in government bond markets”.
In their assessment of the UK’s outlook, the BoE said that households were “under pressure” from higher living costs and noted a rise in the percentage of households with a high debt burden, though the level is still below its 2007 peak.
Households have responded to higher rates by stretching out mortgages for longer, and 12 per cent of mortgages are now for 35 years or more, versus 4 per cent in the first quarter of 2021, the assessment said.
The BoE said that while this trend would reduce payments now, this could “increase debt burdens over the longer term”.
