Bank of England simulates financial stress to gauge systemic risks

In an effort to assess the resilience of the financial system, the Bank of England, under the direction of Andrew Bailey, initiated a ten-day “system-wide exploratory scenario” (SWES) Today. This simulation is designed to scrutinize how non-bank financial institutions would respond under severe stress conditions. The scenario commenced with an extraordinary increase in 10-year gilt yields by about 45 basis points.

The SWES extends beyond this initial shock to incorporate factors reminiscent of recent economic turbulence. It includes the liquidity crisis sparked by the Mini Budget and the ‘dash for cash’ phase seen during the Covid-19 pandemic. As part of the simulation, projections include a rise in gilt yields by 1.15 percentage points, a hike in investment-grade borrowing costs by 1.3 percentage points, and a 0.75 percentage point increase in US Treasury yields.

Andrew Bailey has raised concerns about ‘fragmentation’ in global economic markets, which could pose significant risks. The Bank of England has clarified that the SWES is not intended to be a forecast but rather a tool to analyze potential risks and behaviors under hypothetical stress scenarios. Following the completion of this exercise, institutional responses are expected to be collected in January, with a comprehensive report on the findings slated for release by the end of the year. This proactive approach aims to ensure that financial institutions can withstand adverse conditions without destabilizing the broader economy.

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