Speaker 1: Bloomberg Audio Studios, podcasts, radio news. So we all know
Speaker 1: what the MPC is, Monte Policy Committee at the Bank
Speaker 1: of England. Do you know what the FPC is.
Speaker 2: Yeah, Financial Policy Committee, I now know, but I am
Speaker 2: not surprised that exists.
Speaker 1: And they look basically at the financial shocks that institutions
Speaker 1: could go through and they try and support them in
Speaker 1: understanding where the risks lie but also how they can
Speaker 1: help with growth.
Speaker 3: Yeah.
Speaker 2: I mean, it must be quite an exciting, slash terrifying
Speaker 2: role to have to imagine the very worst shocks, even
Speaker 2: worse than we've seen already, that the banking system could endure.
Speaker 1: So there was a big report that came out on Friday.
Speaker 1: We're going to get into the latest report and dig
Speaker 1: deep to understand what it means for financial institutions and
Speaker 1: where the big risks lie and why this time it's
Speaker 1: a little bit different.
Speaker 2: Welcome to the City of London, the City of London Bank.
Speaker 2: We need to mind the gap between the t and
Speaker 2: the financial hearts of the country.
Speaker 1: The city, the city.
Speaker 2: Welcome to in the city.
Speaker 1: Stand clear of the doors. I'm Francin Laqua, I'm alecro
Speaker 1: Stratton and this week I look at the recent Financial
Speaker 1: Stability Report, what it tells us about how prepared finance
Speaker 1: firms are in times of a crisis. And with us
Speaker 1: Nat Benjamin, who's appointed Executive Director for Financial Stability, Strategy
Speaker 1: and Risk, and of course he is also a member
Speaker 1: of the Financial Policy and Committee. So Nat, thank you
Speaker 1: and welcome to in the city.
Speaker 3: Thank you very much, thank you for having me. It's
Speaker 3: pleasure to be with you.
Speaker 1: Talk to us a little bit about the the FPC.
Speaker 3: There's a number of ways in which the Bank of
Speaker 3: England watches over is to financial stability, and one way
Speaker 3: of doing it is to ensure that individual institutions within
Speaker 3: the financial sector are safe and sound. But another way
Speaker 3: to look at it is to check that the sum
Speaker 3: of the parts adds up and only focusing on individual
Speaker 3: firms is not going to be enough. And that is
Speaker 3: the focus of the Financial Policy Committee, which is to
Speaker 3: ensure that the system as a whole, the financial sector
Speaker 3: as a whole, does its job of ensuring vital services
Speaker 3: to the real economy, to households and business people's ability
Speaker 3: to save, to pay, to borrow what they can afford,
Speaker 3: to invest and to ensure themselves. So that is the
Speaker 3: focus and systemic risks on the focus of the FBC.
Speaker 3: So what do we do while we work to spot them,
Speaker 3: to track them, and to take action to address them.
Speaker 3: And every quarter we get together and we see what
Speaker 3: we think about the key outlook for financial stability at
Speaker 3: a given juncture. But also we consider our more structural
Speaker 3: issues with the financial sector, longer term issues, and that
Speaker 3: is what we did us.
Speaker 1: For how do you look at some of the risks
Speaker 1: out there.
Speaker 3: We had quite a lot of things to say last Friday,
Speaker 3: first the state of the conjuncture at that particular point
Speaker 3: in time, but also we had published the results of
Speaker 3: our stress test of the banks. We had done a
Speaker 3: Desk Bay stress test of the banks to check that
Speaker 3: were strong enough to support the real economy, both in
Speaker 3: good times and in bad time. We had also completed
Speaker 3: and published the result of our systemoid exploratory scenario. So
Speaker 3: that was quite a pioneering initiative. I don't think it's
Speaker 3: been done before, and we're very proud of it. And
Speaker 3: this is the first time we stressed as the entire
Speaker 3: financial sector, one part of the financial sector, rather not
Speaker 3: just just the banks or just the insurance companies. And
Speaker 3: it's very exciting.
Speaker 1: So it was four hundred pages, right, read it all.
Speaker 2: And what does it show? I did read it all,
Speaker 2: but in your own words, what does it show?
Speaker 3: So the first thing was just to show the value
Speaker 3: of such exercises, where instead of just shocking the system
Speaker 3: and seeing what happens, we don't assume the reaction function
Speaker 3: of different players in that ecosystem. We do a flow test,
Speaker 3: so we actually ask them how they would react, and
Speaker 3: then in the second round we factor that in to
Speaker 3: see how a shock plays are we impulse a shock
Speaker 3: on markets that are core to the UK economy and
Speaker 3: we see how it plays out. And now what shocks
Speaker 3: several different markets, different variables, market variables, interest rates, credit variables,
Speaker 3: very severe stress and in combination is probably more severe
Speaker 3: than anything we've seen before, including the financial crash, including
Speaker 3: financial crash, and we apply that to markets that are
Speaker 3: core to the economy like the guilt market, the guilt
Speaker 3: repot market, in the sterling corporate bond market and associated
Speaker 3: interest rates derivatives.
Speaker 2: And even in that scenario, that highest stress scenario, worse
Speaker 2: than the financial crash, did the UK economy start not
Speaker 2: to it or fall ever?
Speaker 3: So what we tested in that system wise exploratory scenario
Speaker 3: was the resilience of those core markets. And the good
Speaker 3: news was that market was proved to be more resilience
Speaker 3: than it was before. That was a positive news. But
Speaker 3: there's no reason.
Speaker 1: For there's always a negative, isn't there.
Speaker 3: Exactly, Well, there's no reason for complacency because those things
Speaker 3: can change fast. So what we need to do is
Speaker 3: to ensure we look in that improvement in resilience to
Speaker 3: deal with whatever the future can bring. That is one conclusion.
Speaker 3: But the other thing we found is that there was
Speaker 3: a very large redistribution of liquidity across the financial sector
Speaker 3: between participants, and the other thing we found is that
Speaker 3: the behavior of market participants amplified the shock, made it worse.
Speaker 1: But you're also one that basically hedge funds, right asset managers,
Speaker 1: and pension providers could be unprepared in times of crisis.
Speaker 3: So that is so.
Speaker 1: There's a part of the financial system which is much
Speaker 1: more risky than the rest.
Speaker 3: That is the fact that I mean the value of
Speaker 3: those exercises to put the spotlight on these things in
Speaker 3: peace time so that everyone gets prepared for when shocks happen.
Speaker 3: So I'll give you an example what we found is
Speaker 3: that a number of market participants, for example, hedgephones, we're
Speaker 3: assuming that if the shock happened, they would be able
Speaker 3: to get extra repot from their banks. And actually we
Speaker 3: asked the banks and the bank said, no, there's not
Speaker 3: going to be more repo. That's an interesting finding. We've
Speaker 3: faded back to the hedgehorons participants so that they can
Speaker 3: factor that in in their own risk management, in their
Speaker 3: own stress testing.
Speaker 1: And I remember being told that, you know, shadow banking
Speaker 1: was the biggest heart spot when interest rates would go up,
Speaker 1: but we haven't really seen that much blow up.
Speaker 3: Well, if you look back at the last five years,
Speaker 3: and I think about those last five years as a
Speaker 3: period of transition away from the post global financial crisis area,
Speaker 3: which is very unique in many respects, into a new norm.
Speaker 3: We're transitioning, and there has been bits of turbulence over
Speaker 3: the last five years. Actually would be a bit bizarre
Speaker 3: if they hadn't been. But every single time we think
Speaker 3: about the archae goos, you think about the dash for cash,
Speaker 3: you think about the LDI think about Nickel. Every single
Speaker 3: time the shock was amplified by those vulnerabilities, by margining practices,
Speaker 3: by the fact that haircuts used to be zero in
Speaker 3: their ramp up very suddenly and the margin call comes
Speaker 3: and there's a big margin call and the counterparty scramss
Speaker 3: around for cash, and that can have a very destabilizing
Speaker 3: effect on financial stability and especially on the markets on
Speaker 3: which those strategies are anchored. So that is why, in
Speaker 3: particular the international policy work which is aiming at those
Speaker 3: vulnerabilities is particularly important. And it's important that these things
Speaker 3: are sorted out in peace time so that you know
Speaker 3: when the shocks happen, well, there isn't such a ramp
Speaker 3: up in the size of the calls or the liquidity.
Speaker 2: So it sounds like you have a function to sort
Speaker 2: of teach some practitioners across the city of London, to
Speaker 2: bring them in and say this is the evidence from
Speaker 2: our analysis and our exercise, and we suggest you behave
Speaker 2: differently in future.
Speaker 3: Well, you see, this has been a really good aspect
Speaker 3: of this particular science. It's just the tone of the conversation.
Speaker 3: It's not an exercise we've done to punish anyone. It's
Speaker 3: just an exercise to find out what would actually happen.
Speaker 3: It is not just in the interest of the Bank
Speaker 3: of England to ensure those markets are resilient. This is
Speaker 3: in the interest of everyone and of all the participants
Speaker 3: because they do business in those markets. And the quality
Speaker 3: of the ton of the conversation was really good, and
Speaker 3: we've got really good feedback from the participants because what
Speaker 3: we've been doing is to be almost maximalist in how
Speaker 3: much we share back to them from what we learn.
Speaker 2: We've talked a lot about how the system might handle
Speaker 2: the sharks, but let's talk about those sharks. And you
Speaker 2: keep talking about peace time, but it's actually quite a
Speaker 2: fraud geopolitical environment right now. When you look at the news,
Speaker 2: when you look at the developments out of America, out
Speaker 2: of Europe and so on. These are the kind of
Speaker 2: shocks you're talking about the system handling, as well as
Speaker 2: more sort of acutely financial ones, aren't they.
Speaker 3: That's right. So, I mean, one of the things we've
Speaker 3: set out last Friday is that global risks are high,
Speaker 3: and the uncertainty and the degree of risk around the
Speaker 3: outlooks has increased, and it matters, particularly because the risk
Speaker 3: of global fragmentation is higher, and fragmentation is not good
Speaker 3: for trades, for financial markets, or for international collaboration and cooperation,
Speaker 3: And there was already pressures on sovereign debts in a
Speaker 3: range of advanced economies, and those pressures have increased. So yes,
Speaker 3: the outlook, the global outlook has become.
Speaker 2: Strict, isn't it because you published last week? But in
Speaker 2: some ways this is a watching brief for all of
Speaker 2: us knowing exactly what the complexion of the Trump decisions
Speaker 2: and so on will be. Does that not matter you
Speaker 2: were did you model, for instance, a tariff regime of
Speaker 2: x percent on UK exports and imports being affected too.
Speaker 3: I mean, this is not about any one country in particular.
Speaker 3: This is a global phenomenon, and on tariff specifically, It's
Speaker 3: too early to tell the impacts that tariffs can have.
Speaker 3: It depends on the reaction function of different jurisdictions. It
Speaker 3: depends on the actual channels that it takes, whether it
Speaker 3: causes inflationary pressure, where the impact is on exchange rates,
Speaker 3: et cetera. And it is not clear keet is not
Speaker 3: obvious that tariffs in and of themselves might have impacts
Speaker 3: on financial stability. Global fragmentation, however, isn't a good thing
Speaker 3: for financial stability. That is for sure.
Speaker 1: We had a big shark in the UK frankly because
Speaker 1: of pensions under this trust. Could that happen again or
Speaker 1: have they taken provisions for that to be tamed.
Speaker 2: Well.
Speaker 3: One of the things we did tests as part of
Speaker 3: the system WOID exploratory scenario is the guild markets and
Speaker 3: importing a shop and guild markets, and we had over
Speaker 3: fifty participants in the exercise, including pension fonds and the
Speaker 3: LII fonds, and what we saw is that they had
Speaker 3: built that resilience since the events you describe, and they
Speaker 3: had higher liquidity buffers, which meant that they were better
Speaker 3: able to manage that shock. However, as we discussed earlier,
Speaker 3: there were other pockets of potential risks that needed to
Speaker 3: be addressed and managed, and those actions are being taken forward.
Speaker 3: So it's really important that all these improvements are locked in,
Speaker 3: as I said, because things can evolve.
Speaker 1: Now do you believe that actually a lot of these actors,
Speaker 1: the hedge funds, the asset managers will look around and say,
Speaker 1: actually we need to minimize risk.
Speaker 3: I think part of the advantages of doing exercise like
Speaker 3: that where we had great, great engagement from participants like
Speaker 3: hedge funds and asset managers, is that it puts the
Speaker 3: spotlight on some of the risks. It put the spotlights
Speaker 3: on the situation in which actually they might take a loss,
Speaker 3: and that is something they can then factor in their
Speaker 3: own internal contingency planning, the risk management and their own
Speaker 3: stress testing. So that is an important aspect of it,
Speaker 3: so that if shocks do happen in the future, their
Speaker 3: impact is lower and is content.
Speaker 1: Can I ask you about regulation, because we're, again, as
Speaker 1: alluded to, at this juncture where we don't really quite
Speaker 1: know what the US does. If they deregulate the banks,
Speaker 1: if they deregulate some of the private companies, some of
Speaker 1: the private equity, some of the credit companies as well,
Speaker 1: does that put the UK in a difficult position to
Speaker 1: decide what to do?
Speaker 3: Again, this is not a question but an in one country.
Speaker 3: But there are calls at the moment for deregulation. You
Speaker 3: can hear them everywhere. And when I hear that, I
Speaker 3: cannot fail to just go back in time a little
Speaker 3: bit and I remember the mid two thousands where there
Speaker 3: were calls for deregulation and quite frankly, it made our
Speaker 3: job more challenging as regulators and supervisors. And then the
Speaker 3: next thing that happened was the global financial crisis, and
Speaker 3: that crisis resulted in a considerable loss of growth for
Speaker 3: many major advanced economies, including the UK, and way beyond
Speaker 3: the immediate terrible impact for households who are losing their homes,
Speaker 3: but these things cost a very long shadow over time,
Speaker 3: and so I think there's a lesson there. Calls for
Speaker 3: deregulation may sound very appealing in the short term, but
Speaker 3: longer term, the people who paid the price for it
Speaker 3: are the people, the households and the businesses. So it's
Speaker 3: quite important that we remember those lessons from history as
Speaker 3: we look aheat. So, having talked about deregulation and the
Speaker 3: fact that we need to not forget those lessons in
Speaker 3: the past, there is a very legitimate question about whether
Speaker 3: the financial sector is doing enough to support growth generally,
Speaker 3: and I think that's a very legitimate question to ask,
Speaker 3: and in particular in areas like payments, innovation, supports for
Speaker 3: climate transition, finance, or the reform of the pension system.
Speaker 3: Those are areas where it's worth asking the question of
Speaker 3: whether there is more the financial sector can do to
Speaker 3: support growth.
Speaker 1: It's a good question, but it's either you go to
Speaker 1: the US style, which is free market deregulation, or you
Speaker 1: force some of the institutions to do some of the
Speaker 1: things that could eventually help with growth.
Speaker 3: I think the idea is to be mindful of those
Speaker 3: lessons from the past and step into the future, but
Speaker 3: in a safe way.
Speaker 1: How's the interaction between private sector and the bank? Do
Speaker 1: you feel like you're understand Yeah? Do you feel like
Speaker 1: you understand each other?
Speaker 3: I do so. In my previous job, I was supervising
Speaker 3: foreign banks in the UK and in the past I
Speaker 3: was very involved in supervision, so directs bank supervision. There's
Speaker 3: a good degree of engagement. If I take a step
Speaker 3: back and I think about and what the UK to
Speaker 3: be known for as a place to do business, and
Speaker 3: when I one of the UK regulators to be known for,
Speaker 3: I want us to be known for the fact that
Speaker 3: people feel they can talk to us. We're approachable, we
Speaker 3: can have a conversation. I want us to be known
Speaker 3: for actually not kicking up a first for nothing. So
Speaker 3: when we do have an issue, you know, we say
Speaker 3: we have an issue, and we're in business and we
Speaker 3: know what we're talking about, We'll not kicking up a
Speaker 3: fast for nothing. Will be proportionate and I want us
Speaker 3: to be known for a place where we're predictable, so
Speaker 3: we don't spring a surprise on people, and people know
Speaker 3: what our reaction function is. So those are the type
Speaker 3: of things I want the UK to be known for.
Speaker 3: And I think that enables a really good dialogue. And
Speaker 3: actually the quality of the dialogue we've had in this
Speaker 3: system wide exercise has been really good. From that perspective.
Speaker 2: We talked about shocks and politics and geopolitics and so on,
Speaker 2: and your survey shows that's what companies are worried about.
Speaker 2: They're worried about that. They're worried about cyber risk as well.
Speaker 2: But just quickly on households, the evidence from I think
Speaker 2: your report is that households, British households are resilient and
Speaker 2: they're doing okay. They're absorbing the increase or certainly elevated
Speaker 2: mortgage amounts. How long does that last? How long do
Speaker 2: you think you're confident that they will remain if we
Speaker 2: have higher interest rates for longer.
Speaker 3: I mean, part of the transition we're going through is
Speaker 3: that it's the real economy going through that transition with
Speaker 3: a higher interest rates. And overall, as you said, the
Speaker 3: picture is that it has been challenging time for household
Speaker 3: but there's been resilient in aggregate. And there's still material
Speaker 3: proportion of households with mortgage for example, who will have
Speaker 3: to refinance on higher rate than they have at the moment.
Speaker 3: But what we've seen is that for those that have
Speaker 3: to refinance on higher rate, the average increase in monthly
Speaker 3: costs to repair their mortgages is lower now than it
Speaker 3: was projected to be in June, for example. So these
Speaker 3: things all depends the key of market.
Speaker 2: Rates, but still higher.
Speaker 3: So there is a wall coming, yeah, but it's a
Speaker 3: lower wall than it was in the past. And the
Speaker 3: sense so far there have been resiliently and we don't
Speaker 3: see any reason for that not to continue. One thing
Speaker 3: we have observed we talked about why financial stability matters
Speaker 3: is so that the financial sector can support household and
Speaker 3: unlike two thousand and eight, where banks made things worse
Speaker 3: and amplified the shocks, what we've seen recently is banks
Speaker 3: supporting household through those difficult times, for example by giving
Speaker 3: them six months to switch on interest only to repay
Speaker 3: their mortgages to give them time to absorb the shock,
Speaker 3: and then reverting back to full repayment. So those are
Speaker 3: the type of things that a strong banking system can
Speaker 3: do to help the economy through a difficult time.
Speaker 2: The other shot would be a climate change shock, and
Speaker 2: I think it used to be a priority. It is
Speaker 2: not anymore because geo politics and cyber and so on.
Speaker 2: But I presume you're still looking at it and still
Speaker 2: feeling that the banks and financial institutions can cope there's a.
Speaker 3: Big climate shock, Yeah, definitely. And we also published a
Speaker 3: refreshed approach to the climate climate risk impact on financials stability.
Speaker 3: An interesting thing with that is that climate risk is
Speaker 3: is not just a long term thing. There are also
Speaker 3: shorter term issues and risk to financial stability coming from
Speaker 3: climate either from flood example, which affect insurers and reinsurers
Speaker 3: and also banks to the extent that homes that are
Speaker 3: subject to flood risk are being the collateral for mortgages.
Speaker 3: Another example is from climate transition risk, where some metals
Speaker 3: are being more more needed for climate transition and there's
Speaker 3: more pressure on those markets, on those commodities markets, and
Speaker 3: we've seen over the last few years a few shocks
Speaker 3: around around those markets, and those impact commodities trading, impact
Speaker 3: the derivatives associated. So those are examples of shorter terms
Speaker 3: financial stability is to climate, and it's important to keep
Speaker 3: monitoring those things, and we'll be incorporating those things as
Speaker 3: relevant into the stress test that we do in the future.
Speaker 1: Now, I guess the difference is I remember, like ten
Speaker 1: fifteen years ago, some of these stress tests, you know,
Speaker 1: felt for me, like a young report at Bloomberg is
Speaker 1: completely far fetched. It was like interest rates at ten percent,
Speaker 1: at twelve percent. And now actually a lot of the
Speaker 1: stress tests seemed to us quite plausible in worst case scenario.
Speaker 1: How do you deal with the fact that some of
Speaker 1: these stress tests could be actually, you know, real life
Speaker 1: quite yeah, that could actually happen instead of being the
Speaker 1: far fetched scenarios.
Speaker 3: Well, I think we've always sought to, you know, use
Speaker 3: scenarios for our stress tests that were severe but plausible.
Speaker 3: And just to give you an example, we've just published
Speaker 3: the result of our desk based stress test of the banks.
Speaker 3: We've used two different scenarios mutually incompatible. They can't happen
Speaker 3: at the same time. One is interest rate going up
Speaker 3: by a lot, and the other one is interest rate
Speaker 3: going down by a lot, And we're completely agnostic about
Speaker 3: which one is more likely than the other one, which
Speaker 3: just apply those two scenarios and see what happens. So
Speaker 3: that is part of what we do to deal with
Speaker 3: what you just said, is to be more exploratory in
Speaker 3: our nature, so that we don't have to speculate on
Speaker 3: what might happen. If it happens, what's the consequence.
Speaker 1: Nott, Thank you so much for joining us. That was great,
Speaker 1: really interesting, very well explained.
Speaker 2: Thanks for listening to this bonus episode of In the
Speaker 2: City from Bloomberg. It was hosted by me Alekri Stratton
Speaker 2: and Francine Laqua. It was produced by Samasadi, production support
Speaker 2: from Moses and Dam and sound designed by Blake Maples.
Speaker 2: Brendan Francis Newnham is our executive producer. Sage Bauman is
Speaker 2: Head of Podcasts Special thanks to Nathaniel Benjamin. Please subscribe, rate,
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