Identities of Shadow Banks That Use New BOE Tool to Remain Secret

The Bank of England will hide the identities of any pension funds, insurers or hedge funds bailed out under a new financial stability tool to prevent a wider crisis engulfing the economy, Deputy Governor Dave Ramsden said.

The BOE has accepted submissions by so-called “shadow banks” that “revealing too much information could create stigma” about using the bail-out tool, which would undermine any rescue effort and risk creating more financial instability, he said in a speech on Monday.

The “systems changes are now all in place” for the new Contingent NBFI Repo Facility (CNRF) but the launch has been delayed slightly until the start of 2025, Ramsden said. The facility will operate as a backstop to the gilt market, which sits at the heart of all UK financial markets given its size and interconnectedness.

The decision to create the CNRF reflects changes to the structure of financial markets since the 2008 financial crisis. Until now, only regulated banks have had access to the BOE balance sheet – which comes with broad regulatory oversight. It also follows the market meltdown following the 2022 mini-budget when liability-driven investment funds desperately needed cash to meet margin calls.

The CNRF will only be used at times of extreme stress, and the the tool may potentially be extended to hedge funds, Ramsden also indicated.

”We are looking at the insurance companies, the life assurers, the LDI funds. That’s where we started. But it’s certainly not where we can stop,” he said in a question-and-answer session following the speech. “There’s going to be further phases as we open this out. We will be going further with the CNRF and, you know, watch this space for where we go beyond that.’

The CNRF will be activated by the bank when “we judge that gilt market dysfunction is severe enough that it threatens financial stability absent any action, and our lending facilities to banks will not, on their own, eliminate that threat,” he said.

Haircuts

Users will be able to place collateral, such as gilts, with the BOE in exchange for cash when other sources dry up. A “haircut” on the collateral will protect the central bank against losses on the asset swap. The BOE effectively provided a similar, unofficial facility in the “dash-for-cash” crisis at the start of the pandemic when market players were able to sell gilts to the BOE through quantitative easing.

Speaking at an OMFIF think tank event, Ramsden said UK financial markets have transformed since the post-2008 crack down on banks, and financial authorities need to respond to the new risks. Nearly all of the increase in net borrowing by UK business since 2008 has come from market-based sources, not banks.

Market-based lending now accounts for 56% of the £1.4 trillion ($1.8 trillion) stock of UK corporate debt, he said. Hedge funds are now huge players in gilt markets, operating as intermediaries, he added. Since 2018, the share of gilt trading volumes conducted by hedge funds has increased to about 28% from 16%.

“Vulnerabilities like hedge fund leverage and concentration are a specific example of the vulnerabilities that could lead to system-wide risks,” Ramsden said. The BOE needs to “monitor and understand what those developments might mean for the financial system.”

The development of the CNRF tool is a recognition of the changed financial risks. The decision to keep the identities of any institutions that use the instrument secret reflects lessons from the financial crisis, when stigma prevented banks using standard BOE liquidity facilities over fears doing looked like they were about to fail.

“Contacts expressed concerns that revealing too much information could create stigma around the use of the CNRF,” Ramsden said. “It’s incredibly important to the bank that we avoid this: the CNRF, like all our facilities, is there so that it can be – and should be – used once it has been activated.”

“To further mitigate the risk of stigma, the bank intends to publish the number of firms that are signed up to the CNRF, but we would not reveal any names; and in the event that we activate the CNRF, we would only disclose borrowing at an aggregate level.”

Photograph: The Bank of England in the City of London. Source: Hollie Adams/Bloomberg