Bank Of England - Financial Stability Report - December 2022

14th December 2022

The Financial Stability Report sets out our Financial Policy Committee's view on the stability of the UK financial system and what it is doing to remove or reduce any risks to it.

Global economic growth is slowing and borrowing costs have gone up
Since our July Financial Stability Report (FSR), the outlook for growth and unemployment in the UK and globally has deteriorated further. Prices have continued to rise rapidly, in considerable part reflecting steep increases in energy and food prices.

In response to these price rises, central banks around the world, including the Bank of England, have been increasing interest rates. These rate rises, and the expectation that they will rise further, have caused the cost of borrowing to rise for households and businesses.

There have been large and rapid moves in financial market asset prices. The price of certain assets - such as risky corporate bonds - have fallen. These trends are due to a combination of the worsening global economic outlook and the potential for further adverse geopolitical developments, including from Russia's invasion of Ukraine. This has increased uncertainty.

UK household and business finances are under growing pressure
Globally, the challenging economic outlook is making it harder for households, businesses and governments to service their debt.

In the UK, monthly payments on around 4 million owner occupied mortgages are expected to increase over the next year. Households may also find it harder to repay other types of debt (eg credit cards and loans), particularly given rising food and energy prices. People are in a better position to manage these changes than they were in previous periods of stress and UK unemployment remains very low by historical standards, although it is expected to rise.

UK businesses have seen their earnings rise and debt fall as the effects of the Covid pandemic have receded. But higher costs, lower demand, rising interest rates, and continued disruption to supply chains are putting pressures on earnings for some businesses. Those most affected may find it harder to repay debts.

UK banks are strong enough to support households and businesses
The UK banking sector is resilient to an economic downturn much worse than the one currently expected. That reflects the large financial buffers they have built up since the 2008 global financial crisis.

We run regular stress tests to ensure major UK banks have big enough buffers to absorb large losses, even during severe downturns. Banks will adjust their lending in an economic downturn given what that means for debt affordability. But their strong position means they are able to support creditworthy households and businesses through the current downturn.

We set the UK countercyclical capital buffer (CCyB) rate each quarter. The CCyB provides banks with an additional ‘rainy day' buffer making sure they can absorb potential future losses without restricting lending to those that are able to repay. The UK CCyB rate will be maintained at 2% with effect from July 2023. We are able to release this buffer if needed to make it easier for the banks to lend to UK households and businesses.

In 2023, there is a need for urgent international action to reduce risks in non-bank finance
Today, more business lending and other financial services come from financial institutions other than banks (ie non-bank financial institutions). This sector includes different types of firms, operating from many countries other than the UK.

We have previously highlighted the need to strengthen the resilience of this sector. In 2023, there is a need for urgent international action to reduce risks in non-bank finance. We will also begin an exploratory scenario exercise focused on non-bank financial institutions. This will help us better understand and reduce the risks associated with them.

At the end of September 2022, rapid and large moves in the interest rates on UK government debt exposed weaknesses in liability driven investment - LDI - funds which are used by UK pension schemes. This weakness threatened UK financial stability and the Bank of England had to intervene temporarily in government debt markets so that the funds could increase their resilience. Had we not acted, the stress would have significantly affected households' and businesses' ability to access credit.

The resilience of this sector needs to be improved in a number of ways to make it more robust. This includes the need for regulatory action to ensure LDI funds keep their higher levels of resilience. Some steps have already been taken, and further work will be done next year.

Note
For much more detail go HERE