Maintaining Liquidity Amidst Global Landscape Shifts
The Bank of England has announced a new approach to the funding and liquidity landscape, with a growing focus on non-bank financial institutions (NBFIs). This shift comes as NBFIs now account for around half of the financial system's assets, globally and in the UK.
Liquidity Allocation and Flow
The Bank aims to ensure that liquidity flows effectively to support vital financial services for households and businesses. This means institutions, including NBFIs, must have the funding to operate effectively.
Recognition of NBFIs’ Role
NBFIs play a key role in providing a range of financial services, operating both alongside and in partnership with banks. They are integral to liquidity provision, particularly in markets like the gilt market which benchmarks sterling-denominated debt.
Risk Awareness and Management
The rise of NBFIs introduces new liquidity and funding risks. Managing these risks requires institutions themselves taking primary responsibility for liquidity risk management, with lessons from past market disruptions guiding the way.
Balanced Policy Framework
The Bank advocates a balanced policy framework that incentivizes institutions to maintain liquidity insurance on their own, but also encourages them to support system-wide liquidity through market lending. Policies should foster market depth and liquidity in normal times, but avoid encouraging unsustainable leverage that could fail in stress.
Liquidity Resilience in Normal and Stressed Times
The Bank of England wants to create a funding and liquidity environment that encourages routine use of central bank lending facilities by banks, promoting normal liquidity management and effective support during stress.
Evolving Guidance and Tools
International frameworks, such as IOSCO’s updated guidance on liquidity risk management for open-ended funds, reflect ongoing efforts to strengthen liquidity risk management practices, governance, stress testing, and disclosures—key given the NBFI sector’s complexity.
In summary, the Bank of England’s approach focuses on integrated, system-wide liquidity management that acknowledges the increasingly important and diverse role of NBFIs, encourages prudent liquidity practices by all financial institutions, and aims to strike a balance between sufficient liquidity provision and avoidance of systemic risk build-up.
The change in the funding and liquidity landscape has implications for the availability of liquidity for NBFIs. The Bank wants to create a funding and liquidity environment which incentivizes banks and NBFIs to participate actively in private sector funding markets. The less efficiently these markets distribute liquidity in normal times, the more likely it is that central banks might have to step in.
Banks should take into account their ability to use the Bank of England's lending facilities regularly for routine liquidity management. This approach is designed to promote a stable and resilient financial system, with NBFIs playing a crucial role in providing services to households and businesses.
Nathanaël Benjamin, Executive Director of Financial Stability Strategy at the Bank of England, emphasized the importance of this shift in focus, stating, "Our new approach recognizes the growing importance of non-bank financial institutions and aims to ensure liquidity flows efficiently to where it is most needed across the financial system."
- The rise of non-bank financial institutions (NBFIs) introduces new risks related to liquidity and funding, requiring these institutions to take primary responsibility for managing liquidity risks.
- With NBFIs now accounting for around half of the financial system's assets, globally and in the UK, AI and technology in data-and-cloud-computing can provide valuable insights for policy makers in maintaining a sustainable financial system.
- Public policy should encourage prudent liquidity practices by all institutions, including NBFIs, ensuring they have the funding to operate effectively in support of vital financial services for businesses and households.
- In a balanced policy framework, institutions are incentivized to maintain liquidity insurance on their own, while simultaneously supporting system-wide liquidity through market lending to avoid unsustainable leverage.
- To incentivize banks and NBFIs to participate actively in private sector funding markets, the Bank aims to create a funding and liquidity environment that encourages routine use of central bank lending facilities.
- Sustainable practices in personal-finance can be reinforced by the efficient distribution of liquidity in normal times, reducing the chances of central banks needing to intervene during stressed times.
- The evolving guidance and tools, such as IOSCO’s updated guidance on liquidity risk management, are key to strengthening liquidity risk management practices and promoting a stable and resilient business environment, reflecting the changing landscape of the financial system with a growing focus on NBFIs.
