Britain’s shadow banking system raises serious concerns after bond market storm

LONDON – After the turmoil in Britain’s bond markets last week in the wake of the government’s “mini-budget” on September 23, analysts sounded the alarm about the country’s shadow banking sector.

The Bank of England I was They had to intervene in the long-term bond market After the massive sale of British government bonds – known as “Government Bonds” – it threatened the country’s financial stability.

The panic is particularly focused on pension funds, which hold large amounts of government bonds, while a sudden rise in interest rate expectations has also caused Chaos in the mortgage market.

While the central bank intervention has provided some fragile stability to British pound and bond markets, analysts noted lingering stability risks in the country’s shadow banking sector – financial institutions that act as lenders or intermediaries outside the traditional banking sector.

Former British Prime Minister Gordon Brown, whose administration provided a rescue package to British banks during the 2008 financial crisis, told BBC Radio on Wednesday that UK regulators will need to tighten their supervision of shadow banks.

“I’m afraid that with inflation going on and interest rates going up, there are going to be a number of companies, a number of organizations that are going to be in a very difficult situation, so I don’t think this crisis is over because pension funds have been bailed out in the past week,” Brown said.

“I think there should be eternal vigilance about what has happened to the so-called shadow banking sector, and I fear there will be other crises to come.”

Global markets have been weighed down in recent sessions by weak economic data, which is seen as reducing the likelihood that central banks will have to tighten monetary policy more aggressively in order to rein in high inflation.

Edmund Harris, chief investment officer at Guinness Global Investors, told CNBC on Wednesday that while inflation will mitigate lower demand and the impact of higher interest rates on household income and purchasing power, the risk is to “grind and expand weak demand.”

The US Federal Reserve has reiterated that it will continue to raise interest rates until inflation is under control, and Harris suggested that monthly inflation rates above 0.2% would be viewed negatively by the central bank, leading to more severe monetary policy tightening. .

Harris suggested that sudden and unexpected changes in the rates at which leverage accumulated in the “dark corners of the market” during the period prior to very low rates could reveal areas of “fundamental instability.”

“Going back to the UK pension fund issue, the requirement for pension funds was to meet the long-term obligations through their holdings of gold bonds, to get the cash flows coming in, but the very low rates meant they weren’t getting the returns, and so they Applying swaps on top – that’s the leverage to get those returns.”

“Non-bank financial institutions, there is likely to be access to financing. If your business is built on short-term financing and one step back, lending institutions have to tighten their belts, tighten credit terms and so on, and start moving toward capital preservation. The people who will go hungry are those who need the most short-term funding.”

Harris suggested that the UK is not there yet, however, there is still ample liquidity in the system at the moment.

“Money will get more expensive, but the availability of money is what happens when you find some kind of breaking point,” he added.

The more debt held by non-bank institutions, such as hedge funds, insurance companies, and pension funds, the higher the risk of a multiplier effect through the financial system. The capital requirements of shadow banks are often set by their counterparties, rather than regulators, as is the case with traditional banks.

This means that when prices are low and there is plenty of liquidity in the system, these collateral requirements are often very low, which means that non-banks need to suddenly provide large collateral when markets are heading south.

Pension funds launched the Bank of England action last week, as some started receiving margin calls due to falling gold values. A margin call is a request by brokers to increase the equity in an account when its value falls below the amount required by the broker.

Sean Corrigan, director of Cantillon Consulting, told CNBC Friday that pension funds themselves were in a fairly strong capital position due to higher interest rates.

“They’re actually now ahead of actuarial financing for the first time I think for five or six years. They’ve obviously had a margin problem, but who’s that little margin?” He said.

“It’s the counterparties who have moved and shuffled them around. If there is a problem, we may not be looking at the correct part of the building that is in danger of falling.”