Skip to main content
  • This website sets cookies on your device. To find out more about how we use cookies please refer to our Privacy and Cookie Policy. By continuing to use the site, we’ll assume that you are content for us to set these on your device.
  • Close
Home > Publications > Quarterly Bulletin Financial Stability Articles

Quarterly Bulletin Financial Stability Articles

2015 Q4
Bonus regulation: aligning reward with risk in the banking sector
By Marilena Angeli and Shahzad Gitay from the Bank’s Cross-Sectoral Policy Division.
Remuneration policies in the banking sector incentivised excessive risk-taking, thereby contributing to the financial crisis. Since the crisis, remuneration rules have come into force to better align employees’ incentives with the long-term health of banks and the financial system. This article explains the key components of the Prudential Regulation Authority’s remuneration rules for banks and considers the direction of the global policy agenda.

The Prudential Regulation Authority’s secondary competition objective
By Stephen Dickinson, David Humphry, Paolo Siciliani and Michael Straughan of the Bank’s Prudential Policy Directorate and Professor Paul Grout, PRA Senior Advisor on Competition.
The Prudential Regulation Authority’s (PRA’s) secondary competition objective requires the PRA to act, where possible, in a way that facilitates effective competition when making policies to advance its primary objectives of safety and soundness, and policyholder protection. This article explains the rationale for the objective, how the PRA interprets it, and what this means for the PRA’s regulation of banks and insurers.

2015 Q3 Bank failure and bail-in: an introduction
By Lucy Chennells and Venetia Wingfield of the Bank’s Resolution Directorate.
During the financial crisis, several governments bailed out failing financial institutions because letting the firms fail and enter insolvency would have caused excessive disruption to the critical services that these institutions provide and to the wider financial system. Following the crisis, the framework for managing the failure of financial firms was reformed and a new tool, known as bail-in, was developed. Bail-in allows the authorities to make sure that shareholders and creditors of a firm bear the costs of failure, without recourse to public funds.
By Andrea French and Mathieu Vital of the Banking and Insurance Analysis Division, and Dean Minot of the Insurance Policy Division.
Insurance companies play an important role in supporting economic activity. But insurers are exposed to a number of risks and can become distressed or fail. This article considers a number of channels through which insurance companies could have adverse effects on financial stability, including: how insurer distress or failure might disrupt the provision of critical services to the real economy; and how their behaviours can propagate systemic risk in the financial system. The Financial Policy Committee has an ongoing workplan to assess the extent of risks to financial stability from insurance companies’ activities.
By Arshadur Rahman of the Bank’s Financial Market Infrastructure Directorate.
Over-the-counter (OTC) derivatives markets have grown significantly over recent decades, and the United Kingdom is an important international centre for them. These markets facilitate the hedging of risk, but they can also give rise to complex exposures within the financial system. Following the financial crisis, policymakers have promoted reforms to these markets. These include the greater use of central counterparties (CCPs) to ‘centrally clear’ transactions, managing risk within the system. The concentration of risk within CCPs does however highlight other challenges, including the need for supervisory co-operation internationally. Authorities are working to address these issues.
​​2015 Q2 Mapping the UK financial system
By Oliver Burrows and Katie Low of the Bank’s Macro-financial Risks Division and Fergus Cumming of the Bank’s Monetary Assessment and Strategy Division.
The United Kingdom’s financial system is large and has grown rapidly in recent decades. Understanding its structure is an important starting point for a wide range of policy questions. One way into this is through the balance sheets of financial firms. This article paints a picture of the financial system by exploring those balance sheets, first using data currently available and then looking ahead to new avenues of research that should further improve our understanding.
By Zijun Liu of the Capital Markets Division, Stephanie Quiet previously of the Banking and Insurance Analysis Division and Benedict Roth of the International Banks Directorate.
Banks can be connected to each other in a number of ways. Greater interconnectedness means that stresses tend to spread more rapidly and extensively across the financial system. Various regulatory initiatives have been introduced to mitigate financial stability risks arising from interconnectedness. On some measures, such as interbank credit exposures, interconnectedness has decreased materially since the financial crisis.
By Robin Swain and David Swallow of the Bank’s Prudential Policy Directorate.
Solvency II is a new regime for the prudential regulation of European insurance companies that will come into force on 1 January 2016. It will modernise the existing regulatory framework, with the objective of providing an enhanced and more consistent level of protection for policyholders across Europe. Solvency II introduces features to improve a firm’s understanding and management of its risks, which should result in improved resilience to shocks.
By Fabrizio Cadamagnani of the Banking and Insurance Analysis Division, Rashmi Harimohan of the Bank’s Monetary Assessment and Strategy Division and Kumar Tangri of the Risk Infrastructure, Liquidity and Capital Division.
Banks determine the interest rates on loans and deposits through an internal pricing approach that seeks to take account of the relevant costs and risks of their business. This article focuses on ‘funds transfer pricing’ (FTP), a key component of banks’ internal pricing methodologies. It discusses issues in some banks’ FTP practices, the impacts of economic and regulatory developments on FTP, and some potential implications for monetary and financial stability.

2015 Q1 ​​​Investment banking: linkages to the real economy and the financial system
By Kushal Balluck of the Bank’s Banking and Insurance Analysis Division.
Investment banks play a key role in capital markets and contribute to the efficient functioning of financial markets. As demonstrated in the recent financial crisis, however, investment banks can create and propagate risks in the financial system given their scale, as well as the interconnected and complex nature of their activities. Recognising investment banks’ systemic importance, a number of international regulatory initiatives have come into force since the onset of the recent financial crisis.

Desperate adventurers and men of straw: the failure of City of Glasgow Bank and its enduring impact on the UK banking system
By Richard Button and Samuel Knott of the Bank’s Financial Stability Strategy and Risk Directorate, and Conor Macmanus and Matthew Willison of the Bank’s Prudential Policy Directorate.
City of Glasgow Bank was the largest commercial banking failure in the United Kingdom prior to the recent financial crisis and arguably shaped the future structure of the UK banking system.

​2014 Q4 Bank funding costs: what are they, what determines them and why do they matter?
By Emily Beau of the Bank’s Banking Policy Division, John Hill of the Major Banks and Insurers Sectoral Division, Tanveer Hussain of the Markets Directorate and Dan Nixon of the Bank’s Media and Publications Division.
A bank needs to finance its activities, and the cost of bank funding affects a wide range of economic variables with important implications for both monetary and financial stability. This article sets out what bank funding costs are in simple terms, using an analogy of two buckets on a pair of scales to help explain the dynamic nature of bank funding and bank lending. It also introduces a simple framework for analysing the main drivers of funding costs.
By Oliver Bush of the Bank’s Macroprudential Strategy and Support Division, Samuel Knott of the Bank’s Stress Testing and Strategy Division and Chris Peacock of the Prudential Regulation Authority’s International Banks Supervision Directorate.
Over the past 40 years the size of the UK banking system has grown dramatically and under plausible assumptions it could continue to grow rapidly. This article examines a number of issues related to the size of the UK banking system, including why it is so big and what empirical evidence tells us about the relationship between banking system size and financial stability. This evidence suggests that while size can be important, it is the resilience of the banking system that is key for financial stability.
By Tamarah Shakir of the Bank’s Macroprudential Strategy Division and Matthew Tong of the Bank’s Monetary Assessment and Strategy Division.
The Bank’s Financial Policy Committee (FPC) and Monetary Policy Committee (MPC) are separate committees, each with their own primary objectives, but with a common secondary objective. In addition, the policy actions of one committee can affect economic and financial variables of interest — and hence the policy stance — of the other. There are clear benefits from having two separate committees. But there is also considerable scope for, and benefits from, effective information sharing and dialogue between the FPC and MPC, and a shared understanding of each committee’s approach to policymaking.
By Andrew Gracie, Executive Director, Resolution, and Lucy Chennells and Mark Menary of the Bank’s Resolution Directorate.
The Bank of England has an objective to protect and enhance UK financial stability, as part of which firms must be able to fail without destabilising the rest of the financial system. Resolution is the process by which the UK financial authorities can intervene to manage the failure of a firm in an orderly way. The aim is to ensure continuity of the critical economic functions and services provided to customers, and that the costs of failure are borne by shareholders and unsecured creditors rather than taxpayers.
By Gareth Anderson of the Bank’s Monetary Assessment and Strategy Division, Philip Bunn and Alice Pugh of the Bank’s Structural Economic Analysis Division and Arzu Uluc of the Bank’s Macro Financial Risk Division.
This annual article on the latest survey of households carried out by NMG Consulting on behalf of the Bank focuses on the potential impact of higher interest rates. If interest rates were to rise by two percentage points, while over the same period incomes rose by 10%, then the proportion of households with a high mortgage debt servicing ratio would rise from 1.3% to 1.8%. However, this remains well below previous peaks for this metric. Overall, the evidence does not suggest that gradual increases in interest rates from their current historically low levels would have unusually large effects on household spending.
​​​2014 Q3 The economics of digital currencies (95KB)
By Robleh Ali of the Bank’s Financial Market Infrastructure Directorate, John Barrdear of the Bank’s Monetary Assessment and Strategy Division, and Roger Clews and James Southgate of the Bank’s Markets Directorate.
Although digital currencies could, in theory, serve as money for anybody with an internet-enabled device, at present they act as money only to a limited extent and only for relatively few people. The economics of the schemes as currently designed, both in terms of individuals’ incentives and at a macroeconomic level, pose significant challenges to their widespread adoption. Digital currencies do not currently pose a material risk to monetary or financial stability in the United Kingdom. The Bank continues to monitor developments in this area.

By Rashmi Harimohan of the Bank’s Monetary Assessment and Strategy Division and Benjamin Nelson of the Bank’s Prudential Policy Directorate.
Macroprudential capital policy is designed to make the financial system more resilient and reduce the likelihood and severity of financial crises. In doing so, it can have an impact on credit conditions and economic growth more generally. This article considers the effects on credit conditions over the near term. The direction and magnitude of those effects are likely to depend crucially on the state of the financial system and the economy as well as the way in which banks, financial investors and borrowers respond to changes in macroprudential capital policy.

By Philip Bunn of the Bank’s Structural Economic Analysis Division and May Rostom of the Bank’s Banking System Division.
This article is the first study to use microdata to assess the role of debt levels in determining UK households’ spending patterns over the course of the recent recession. There is evidence that high levels of household debt have been associated with deeper downturns and more protracted recoveries in the United Kingdom. Cuts in spending associated with debt are estimated to have reduced the level of aggregate private consumption by around 2% after 2007, unwinding the faster growth in spending by highly indebted households, relative to other households, before the financial crisis.

​​2014 Q1

Dealing with a banking crisis: what lessons can be learned from Japan’s experience? (257KB)
By Benjamin Nelson of the Bank’s Monetary Assessment and Strategy Division and Misa Tanaka of the Bank’s Prudential Policy Division.
This article examines Japan’s policies in dealing with its banking crisis during the 1991–2004 period, in order to draw lessons for policymakers today. Japan’s policy choices reflected a difficult trade-off between the need to contain moral hazard on the one hand, and the need to limit systemic risk on the other. The resolution of the crisis ultimately required recapitalising banks and resolving uncertainty over banks’ asset valuations.

The role of business model analysis in the supervision of insurers (74KB)
By John Breckenridge of the Prudential Regulation Authority’s Insurance Directorate and James Farquharson and Ruth Hendon of the Prudential Regulation Authority’s Policy Division.
The Prudential Regulation Authority (PRA) supervises insurance companies since, in the absence of regulation, there could be adverse effects for policyholders and financial stability. Like all firms, insurers’ business models — the ways they make profit — and the risks they face evolve over time. The PRA uses business model analysis (BMA) as part of its forward-looking supervisory approach, to help to ensure that these evolving risks are recognised. This article explains the use of BMA, using as case studies the rise of price comparison websites in the motor insurance market, and the growth of non-standard annuity products for life insurers.

2013 Q4

SME forbearance and its implications for monetary and financial stability (81KB)
By MartinArrowsmith and MartinGriffiths of the Bank’s Prudential Regulation Authority, JeremyFranklin, EvanWohlmann and GarryYoung of the Bank’s Monetary Analysis Directorate and DavidGregory of the Bank’s Financial Stability Directorate.
This article presents the results of an investigation into the extent of loan forbearance in the SMEsector and its implications for productivity and financial system resilience. Around 6% of SME borrowers were estimated to be in receipt of some form of loan forbearance in March2013. This accounted for around 14% of the major five UKbanks’ exposure to this sector. SME forbearance appears to account for only a small proportion of the weakness in aggregate UKproductivity and also seems unlikely to threaten financial system resilience.

Bringing down the Great Wall? Global implications of capital account liberalisation in China (106KB)
By John Hooley of the Bank’s International Finance Division.
Capital account liberalisation in China and internationalisation of the renminbi would have a large impact on the global financial system. An illustrative thought experiment suggests China’s gross international investment position could increase from around 5% to 30% of world GDP by 2025. The UK financial system is likely to be particularly affected. The Bank is working with the People’s Bank of China to ensure a successful and stable development of renminbi activity in London.

Banks’ disclosure and financial stability (110KB)
By Rhiannon Sowerbutts and Peter Zimmerman of the Bank’s Financial Stability Directorate and Ilknur Zer of the Board of Governors of the Federal Reserve System.
Inadequate public disclosure by banks contributed to the financial crisis. This is because investors, unable to judge the risks that banks are bearing, withdraw lending in times of systemic stress. This article presents quantitative indices which allow for the comparison of disclosure between banks and over time. Internationally, disclosure has improved since 2000, particularly around banks’ valuation methods and funding risk. However, more information alone is not sufficient to solve the problem. More needs to be done to ensure that the information provided is useful to investors, and that investors are incentivised to use this information. The ongoing reform agenda aims to address this.
​2013 Q3
Macroprudential policy at the Bank of England (77KB)
By Paul Tucker, Deputy Governor for Financial Stability, and Simon Hall and Aashish Pattani of the Bank’s Macroprudential Strategy Division.
A vital element of recent reforms to the UK architecture of financial regulation is the creation of a macroprudential authority at the Bank of England — the Financial Policy Committee (FPC). This article explains the role and powers of the FPC in relation to risks that threaten the resilience of the UK financial system as a whole. It also describes some of the processes supporting the new committee.

Bank capital and liquidity (110KB)
By Marc Farag of the Bank’s Financial Stability Directorate, Damian Harland formerly of the PRA’s Banking Policy Department and Dan Nixon of the Bank’s Media and Publications Division.
Bank capital, and a bank’s liquidity position, are concepts that are central to understanding what banks do, the risks they take and how best those risks should be mitigated. This article provides a primer on these concepts. It can be misleading to think of capital as ‘held’ or ‘set aside’ by banks; capital is not an asset. Rather, it is a form of funding — one that can absorb losses that could otherwise threaten a bank’s solvency. Meanwhile, liquidity problems arise due to interactions between funding and the asset side of the balance sheet — when a bank does not hold sufficient cash (or assets that can easily be converted into cash) to repay depositors and other creditors. The article also explains the role of prudential regulation of banks, which seeks to ensure that banks have sufficient capital and liquidity resources to properly account for the risks that they take.

The rationale for the prudential regulation and supervision of insurers (60KB)
By Simon Debbage of the Bank’s Financial Stability Directorate and Stephen Dickinson of the Prudential Regulation Authority’s Regulatory Policy Department.
The financial crisis has necessitated a re-examination of the level, nature and distribution of risk across the financial system, including insurance companies. In April 2013, the Prudential Regulation Authority, as part of the Bank of England, became responsible for the prudential regulation and supervision of insurers. But the degree to which a common understanding has been reached on how insurers might affect financial stability is lower than, for example, the analogous discussion for banks. In a Workshop hosted by the Bank in July2013, the risks posed by insurers for both insurance policyholders and financial stability were discussed, together with what this might mean for how insurers should be regulated and supervised.

​2013 Q2
Cross-border bank credit and global financial stability (109KB)
By Bob Hills and Glenn Hoggarth of the Bank’s International Finance Division.
This article looks in detail at one aspect of global liquidity:  cross-border credit provided by banks.  Cross-border banking can potentially have considerable benefits, especially by diversifying the available sources of lending and borrowing, and by increasing banking competition.  But such flows can also amplify risks in times of stress.  As this article sets out, cross-border bank lending contributed to the build-up in vulnerabilities before the recent crisis, and exacerbated the bust once the crisis hit.  The article then considers possible policy responses, arguing in particular that policymakers need to ensure that they can properly monitor these flows, from the point of view of recipient countries and the global system as a whole.
Central counterparties:  what are they, why do they matter and how does the Bank supervise them? (85KB)
By Amandeep Rehlon of the Bank’s Market Infrastructure Division and Dan Nixon of the Bank’s Media and Publications Division.
The Government introduced major changes to the system of financial regulation in the United Kingdom in April 2013, including creating the Financial Policy Committee and transferring significant new supervisory responsibilities to the Bank.  As part of this, the Bank is now responsible for the supervision of central counterparties, or CCPs.  This article explains what CCPs are, setting out their importance for the financial system — including the benefits they bring and some of the risks they could present if not properly managed.  It also summarises the Bank’s approach to supervising CCPs and describes some of the key priorities the Bank will be pursuing.
2013 Q1 Changes to the Bank of England (80KB)
By Emma Murphy of the Bank’s Macroprudential Strategy Division and Stephen Senior of the Bank’s PRA Transition Unit.
The Bank of England is currently experiencing its most important institutional and functional changes in a generation.  Failings in pre-crisis arrangements have prompted the Government to introduce wholesale changes to the UK regulatory landscape which come into force in April 2013.  This regulatory reform has resulted in the Bank gaining significant new responsibilities, including for:  microprudential regulation of insurers, deposit-takers and major investment firms, through the creation of the Prudential Regulation Authority;  macroprudential regulation of the financial system as a whole, through the creation of the Financial Policy Committee;  and supervision of some critical post-trade financial market infrastructure providers.  This article summarises the main changes to the Bank arising from these reforms, including those already put in place in anticipation of the reforms, as well as the new governance arrangements that are being introduced, as part of the Bank’s accountability to Parliament and the public.
By David Gregory of the Bank’s Markets, Sectors and Interlinkages Division.
In the mid-2000s, there was a dramatic increase in acquisitions of UK companies by private equity funds.  The leverage on these buyouts, especially the larger ones, was high.  The resulting increase in indebtedness makes those companies more susceptible to default, exposing their lenders to potential losses.  This risk is compounded by the need for companies to refinance a cluster of buyout debt maturing over the next few years in an environment of much tighter credit conditions.  From a macroprudential policy perspective it will be important to monitor the use of debt in acquisitions in future episodes of exuberance.  But there is also a potential role for private equity to play in promoting recovery in a downswing, in particular at the current juncture, by restructuring companies in difficulty.
Commercial property and financial stability (112KB)
By James Benford and Oliver Burrows of the Bank’s Financial Stability Directorate.
Commercial property played a key role in the recent financial crisis in the United Kingdom.  A rapid build-up of debt tied to commercial property investments pre-crisis supported a boom in prices.  The consequent bust led to a sharp rise in non-performing loans.  This episode has many precedents in the United Kingdom and parallels across countries.  The structure of the commercial property market, and in particular the role of leveraged investors with significant maturity mismatches on their balance sheets, is important in understanding the market’s dynamics and the risks it can pose.  The new Financial Policy Committee will be alert to these risks and deploy tools to counteract them where necessary to protect financial stability.
​2012 Q4 The role of designated market makers in the new trading landscape (119KB)
By Evangelos Benos and Anne Wetherilt of the Bank’s Payments and Infrastructure Division.
Designated market makers (DMMs) have traditionally been a source of liquidity for exchange-traded securities and financial contracts.  Recent regulatory and technological developments, however, have changed the environment in which DMMs operate, raising questions about their place in the new trading landscape.  This article discusses the role and challenges of DMMs in today’s trading venues.
By Andrew Bailey, Executive Director of the Bank of England and Managing Director of the Financial Services Authority’s Prudential Business Unit, and Sarah Breeden and Gregory Stevens of the Bank’s PRA Transition Unit.
The Prudential Regulation Authority (PRA), as part of the Bank of England, will become the United Kingdom’s prudential regulator for banks, building societies and credit unions (collectively deposit-takers), insurers and major investment firms in 2013.  This is part of a wider reform of the UK regulatory framework, which will also see the creation of a Financial Policy Committee within the Bank, and a new conduct regulator, the Financial Conduct Authority.  This article provides a brief description of the PRA’s role and its intended supervisory approach.  It summarises some of the key themes of the two more detailed documents about the PRA’s intended approach that were published jointly by the Bank and the Financial Services Authority in October 2012.

2012 Q3 RAMSI:  a top-down stress-testing model developed at the Bank of England (72KB)
By Oliver Burrows, David Learmonth, Jack McKeown and Richard Williams of the bank's Risk Assessment Division.
Top-down stress testing is one way of assessing the resilience of the financial system to the risks it might face now or in the future.  The Risk Assessment Model of Systemic Institutions (RAMSI) developed at the Bank of England is an example of a top-down stress-testing model and is part of the Bank’s risk assessment toolkit.  This article offers an overview of RAMSI and illustrates its use in the stress tests carried out during the IMF’s 2011 UK Financial Stability Assessment Program.

​2012 Q2 Considering the continuity of payments for customers in a bank’s recovery or resolution (54KB)
By Emma Carter of the Bank’s Customer Banking Division.
The robustness of payments infrastructure, and the associated ability of payments to flow seamlessly, is an important contributor to financial stability.  The United Kingdom’s payments infrastructure has historically proved to be efficient and robust.  But, in a situation where a bank is in difficulty or fails, the need to ensure that customers can continue to make and receive payments may become challenging.  This article draws together and discusses some of the issues in the way that UK payments and payment schemes work in stressed scenarios.  It highlights some possible enhancements which could help to achieve minimal disruption to payment flows in the event that a bank gets into difficulty or fails — a subject the authorities, payment schemes and banks have been addressing in recent months.  It looks at elements of recovery and resolution planning from the specific perspective of retail payments.

​2012 Q1
The Bank of England’s Special Liquidity Scheme (89KB)
By Sarah John, Matt Roberts and Olaf Weeken of the Bank’s Sterling Markets Division.
The Bank of England introduced the Special Liquidity Scheme (SLS) in April 2008 to improve the liquidity position of the UK banking system.  It did so by helping banks finance assets that had got stuck on their balance sheets following the closure of some asset-backed securities markets from 2007 onwards.  The Scheme was, from the outset, intended as a temporary measure, to give banks time to strengthen their balance sheets and diversify their funding sources.  The last of the SLS transactions expired in January 2012, at which point the SLS terminated.  During the period in which the SLS was in operation, the Bank undertook a fundamental review of its framework for sterling market operations and developed a new set of facilities to provide ongoing liquidity insurance to the banking system.  This article explains the design and operation of the SLS and describes how that experience has influenced the design of the Bank’s permanent liquidity insurance facilities.

2011 Q3

Bank resolution and safeguarding the creditors left behind (88KB)
By Geoffrey Davies and Marc Dobler of the Bank’s Special Resolution Unit.
Not for the first time, the global banking crisis illustrated the vulnerability of banks to a loss of confidence by their depositors, other creditors and counterparties.  The experience highlighted the need to have special arrangements for dealing with failing banks — a ‘special resolution regime’ — that provides the authorities with the tools necessary to reduce the systemic risks arising from a bank’s failure while at the same time limiting the taxpayers’ exposure to the costs.  The United Kingdom’s own Special Resolution Regime for dealing with failing banks and building societies was borne out of the difficulties in dealing with the failure of Northern Rock in the autumn of 2007.

Developments in the global securities lending market (111KB)
By Matthew Dive of the Bank’s Payments and Infrastructure Division, Ronan Hodge and Catrin Jones of the Bank’s Financial Institutions Division and James Purchase of the Bank’s Sterling Markets Division.
Securities lending plays an important role in supporting financial markets.  For example, it can improve market liquidity, potentially reducing the cost of trading and increasing market efficiency.  But by increasing the interconnections between institutions it can pose potential risks to financial stability, which are exacerbated by a lack of transparency in the securities lending market.  Since the onset of the financial crisis, market participants have attempted to address some of these risks, and fundamental changes to market infrastructure are being discussed, such as the use of central counterparties.  New regulations under way to improve the resilience of the financial system may also impact both the risks to financial stability from securities lending and its benefits.

2010 Q4 The Bank’s money market framework (84KB)
By Roger Clews, Chris Salmon and Olaf Weeken of the Bank’s Sterling Markets Division.
The Bank of England implements the policy stance of the Monetary Policy Committee through its operations in the sterling money markets. It also uses these operations to reduce the costs of disruption to the liquidity and payment services supplied by banks. In order to ensure their continued effectiveness, it was necessary to adapt the framework for these operations in response to the significant changes to financial and monetary conditions that occurred during the recent financial crisis. This article describes how central banks can use their money market operations to implement monetary policy and provide liquidity support to banks and some of the issues that can arise when undertaking operations to achieve these two objectives. The article goes on to explain the Bank’s choices about its own operating framework, including how its thinking has been influenced by the lessons learned during the financial crisis.

  Evolution of the UK banking system (112KB)
By Richard Davies and Peter Richardson of the Bank's Financial Institutions Division and Vaiva Katinaite and Mark Manning of the Bank's Prudential Policy Division.
The financial system provides three key services: payment services, intermediation between savers and borrowers, and insurance against risk. These services support the allocation of capital, and the production and exchange of goods and services, all of which are essential to a well-functioning economy. While the basic financial services are relatively timeless, the characteristics of the system providing them change continuously, in response to both economic and regulatory developments. This article tracks the evolution of a core component of the financial system in the United Kingdom, the banking sector, describing how technology has transformed the economics of banking, and how deregulation in the 1970s and 1980s freed banks to take advantage of new opportunities through globalisation and financial innovation. The result has been the emergence of large, functionally and geographically diverse banking groups. Post-crisis, public-policy attention has been focused on the costs of a banking sector dominated by large and complex institutions that are seen as too important to fail.

2010 Q2 Collateral risk management at the Bank of England (384KB)
By Sarah Breeden, Head of the Bank's Risk Management Division and Richard Whisker of the Risk Management Division.
In response to the financial crisis the Bank of England has expanded the range of collateral accepted in its market operations to include private sector assets, notably asset-backed securities and covered bonds. Such assets have different risk characteristics to the forms of collateral previously accepted, presenting new risk management challenges. This article sets out how the Bank of England undertakes collateral risk management, highlighting in particular the significant degree of protection taken by the Bank in its operations.

2010 Q1 The Bank's balance sheet during the crisis (421KB)
By Michael Cross of the Bank's Foreign Exchange Division, Paul Fisher, Executive Director Markets and Olaf Weeken of the Bank's Sterling Markets Division.
This article sets out how monetary policy implementation and liquidity provision during the financial crisis have affected the size and composition of the Bank of England's balance sheet. It extends and updates a recent speech by Paul Fisher, Executive Director Markets, and describes the main components of the Bank's balance sheet prior to and during the crisis.

2009 Q3 Bank of England Systemic Risk Survey (489KB)
By Sarah Burls of the Bank's Risk Assessment Division.
Earlier this year, the Bank introduced a formal Systemic Risk Survey to supplement its regular dialogue with market participants. The survey is intended to elicit market participants' views about the prospects for financial stability in the United Kingdom. This article introduces the survey and reports the key results, following the summary published in the June 2009 Financial Stability Report.

2009 Q2 The economics and estimation of negative equity (432KB)
By Tomas Hellebrandt of the Bank's Monetary Assessment and Strategy Division, Sandhya Kawar of the Bank's Systemic Risk Assessment Division and Matt Waldron of the Bank's Structural Economic Analysis Division.
Negative equity occurs when the market value of a house is below the outstanding mortgage secured on it. As house prices fall, the number of households in negative equity tends to rise. Between the Autumn of 2007 and the Spring of 2009, nominal house prices fell by around 20% in the United Kingdom . There are no data which accurately measure the scale of negative equity. Three estimates presented in this article suggest that around 7%-11% of UK owner-occupier mortgagors were in negative equity in the Spring of 2009, although for most of those households, the total value of negative equity was relatively small. The effects of negative equity can be painful for those households concerned. Negative equity can also have implications for both monetary policy and financial stability, which are discussed in this article. These effects are likely to depend on developments elsewhere in the macroeconomy and financial system.

2008 Q1

Capital inflows into EMEs since the millennium:  risks and the potential impact of a reversal (651KB)
By Guillermo Felices, Glenn Hoggarth and Vasileios Madouros of the Bank's International Finance Division.
Capital inflows into emerging market economies (EMEs) were at a record level in 2007 and higher than prior to the East Asian and Russian crises a decade earlier. These inflows largely reflect improvements in EMEs' economic and financial strength in recent years. But some EMEs, especially in Central and Eastern Europe, may be vulnerable to a reversal of capital flows if the global credit squeeze is prolonged or global GDP growth falls sharply. This could adversely affect both EMEs and foreign investors.

Recent developments in portfolio insurance (2.2MB)
By Darren Pain of the Bank's Foreign Exchange Division and Jonathan Rand of the Bank's Sterling Markets Division.
The aim of this article is to describe how portfolio insurance works, the main strategies employed and how these have evolved over recent years, and the possible links between their use and financial market stability. The key benefit of portfolio insurance is that it enables financial risk to be distributed among those agents most willing to absorb it. The downside is that it can possibly create conditions for greater fragility in financial markets and leaves issuers of portfolio insurance exposed to potential unexpectedly high losses. It seems unlikely that portfolio insurance-related investments contributed significantly to the financial market volatility that began in Summer 2007. Nonetheless, it is important to keep alert to situations when portfolio insurance could potentially work to amplify financial market instability.

2006 Q3 Costs of sovereign default (506KB)
By Bianca De Paoli of the Bank's Monetary Instruments and Markets Division, Glenn Hoggarth of the Bank's International Finance Division and Victoria Saporta of the Bank's Systemic Risk Reduction Division.
Over the past quarter of a century, emerging market economies (EMEs) have defaulted on their sovereign debts frequently. This article assesses the size and types of costs that have been associated with these defaults. It emphasises that costs, measured by the fall in output, are particularly large when default is combined with banking and/or currency crises. Output losses also seem to increase the longer that countries stay in arrears or take to restructure their debts. The paper concludes with a number of policy suggestions to improve debt crisis prevention and management and the role played by the IMF.

Winter 2005 Financial stability, monetary stability and public policy (151KB)
By Chay Fisher, System Stability Department, Reserve Bank of Australia and Prasanna Gai of the Bank’s Systemic Risk Assessment Division.
The interplay between financial and monetary stability has received considerable attention in recent times, from policymakers and academics alike. This article reviews the broad themes that have emerged in the recent literature and highlights several key issues that merit attention by researchers. In particular, the optimal combination of instruments designed to achieve these twin goals of policy simultaneously remains a relatively underexplored area of research.