The Bank’s Financial Stability Strategy

Organisation of responsibilities

The Bank is responsible for the delivery of its financial stability objective in line with this strategy.

The Bank has two statutory bodies with responsibilities to make specific contributions to UK financial stability:

• The Financial Policy Committee (FPC) is responsible for identifying, monitoring, and taking action to remove or reduce systemic risks with a view to protecting and enhancing the resilience of the UK financial system. The FPC sets macroprudential policy, relating to the stability of the financial system as a whole. In meeting this responsibility, the FPC maintains an overview of the UK’s microprudential regulatory and supervisory frameworks relating to individual financial institutions and any financial stability issues arising in relation to these. Subject to achieving that, the FPC should act in a way that supports the economic policy of the Government. The FPC has specific powers of Direction over two microprudential authorities, the Prudential Regulation Authority (PRA) and Financial Conduct Authority (FCA), and the ability to make ‘comply or explain’ Recommendations to both authorities; it has the ability to make Recommendations to any other person, including relevant authorities on action necessary to conserve financial stability.
• The PRA is the microprudential regulator of banks, building societies, credit unions, designated investment firms and insurers. It must take into account financial stability considerations when advancing its general objective to promote the safety and soundness of the firms it regulates. The PRA also has an objective to protect insurance policyholders and a secondary objective to facilitate effective competition^{footnote [6]}. The PRA’s most important decisions are taken by the Prudential Regulation Committee (PRC) of the Bank. The strategy for delivering its statutory objectives was set by the PRC in consultation with the Bank’s Court of Directors and published in the PRA Business Plan 2022/23.^{footnote [7]}

The Bank has statutory responsibilities in relation to financial market infrastructure (FMI) and resolution:

• The FMI Board exercises the Bank’s powers in relation to FMIs, and the Bank’s strategy with respect to FMI supervision is set out in an approach document, with updates provided in the Bank of England’s Annual Report on FMI supervision.^{footnote [8]}
• The Bank is the resolution authority for the United Kingdom and has published its approach to resolution, and to how it assesses UK banks’ resolvability.

The Bank uses its balance sheet, operations, the provision of critical infrastructure (including the RTGS service), and the production and distribution of banknotes to support financial stability.

The Monetary Policy Committee (MPC) has responsibility for formulating monetary policy with an objective to maintain price stability. Price stability reduces the scale of economic fluctuations over time, and so supports financial stability.

The Bank also relies on other UK authorities to meet their responsibilities. For example, HMT determines the regulatory framework for the UK financial system and is able to specify which activities should be regulated and which activities should be prudentially regulated by the PRA. The FCA is the conduct regulator for financial companies and financial markets in the United Kingdom and the prudential regulator for some of those firms, including asset managers, consumer credit providers and insurance brokers. The Pensions Regulator is responsible for regulating and overseeing workplace pensions, ensuring employers meet their legal obligations, and taking action to protect members' interests.

A Memorandum of Understanding outlines how HMT, the Bank and the PRA will co-ordinate with each other in the run-up to and during the resolution of a firm. As resolution authority, the Bank decides which resolution tools to use and carries out the resolution, except for temporary public ownership and public equity support, for which HMT is responsible. HMT must also authorise the use of any resolution power which would have implications for public funds.

Guiding principles for the Bank’s Financial Stability Strategy

A stable financial system is one that has sufficient resilience to be able to facilitate and supply vital services by financial institutions, markets and market infrastructure to households and businesses, in a manner that absorbs rather than amplifies shocks. Those vital services are:

• the provision of payment and settlement services;
• intermediating between savers and borrowers, and channelling savings into investment; and
• insuring against and dispersing risk.

The Bank protects and enhances the stability of the financial system by:

• Ensuring the financial system remains resilient;
• Promoting the safety, soundness and resolvability of firms and the resilience and reliability of financial market infrastructure;
• Providing secure and reliable payments infrastructure, market operations, banking services and banknotes.

In doing so, the Bank’s approach reflects the fact that:

• The UK is a leading international financial centre. The UK’s financial services sector and the wider UK economy benefit from that openness and competitiveness. But it also means that the UK is exposed to shocks from abroad. Actions of UK authorities to set standards, and its leadership in setting global standards, contribute to international as well as domestic financial stability. The UK’s institutions and markets must be a source of strength for the global system and able to be relied upon by others. The IMF considers that the stability of the UK financial system is therefore a global public good.^{footnote [9]}
• Financial stability is not about the elimination of all risks or minimising volatility in the financial system. It is about identifying, monitoring and taking action to remove or reduce systemic risks – those that could severely impair the supply of the financial system’s vital services.
• The necessary resilience must be delivered efficiently, so as not to hamper the ability of the system to serve the real economy.

The Bank’s approach aims to be in step with the changing needs of the economy, and the changing financial system. It therefore supports improvements to the provision of financial services to the economy by facilitating sustainable innovation in the financial system. This is reflected in the Bank’s strategic priorities^{footnote [10]}, which allow the Bank and the financial system to adapt safely to opportunities, and to technological and environmental changes.

The experience of recent years, including the Covid pandemic, Russia’s invasion of Ukraine, and stresses in market-based finance, show more than ever the importance of maintaining confidence in the ability of the financial system as a whole to remain resilient and absorb rather than amplify shocks.

Key elements of the Bank’s Financial Stability Strategy

The strategy has three broad elements:

a: Maintain a robust baseline level of resilience for the UK financial system;

b: Continue to identify risks to the economy that could emerge from the UK or global financial system, and take action where necessary; and

c: Facilitate sustainable innovation in the UK financial system, including to support the changing needs of households and businesses.

a: Maintain a robust baseline level of resilience for the financial system

1. Implement robust prudential regulation in the UK in line with relevant international standards. Going forward, UK financial stability will require levels of resilience at least as great as those put in place since the global financial crisis and required by international baseline standards, and – recognising the importance of the UK as an international financial centre – in some cases greater.

2. Maintain a safe and open regulatory regime. The Bank aims to ensure a fit for purpose UK regulatory regime that underpins a resilient and dynamic international financial sector that is safely open to the rest of the world. Strong standards and a resilient financial system also support the UK’s competitiveness by providing firms, customers and counterparties with reassurance that they can do business here with confidence. Following the UK’s withdrawal from the EU, HM Government is taking action, through the Financial Services and Markets Bill,^{footnote [11]} to ensure that the UK maintains a coherent, agile, and internationally respected approach to financial services regulation that delivers appropriate protections and promotes financial stability.

3. Recognising the importance of the UK as a global financial centre - and working with other UK and international authorities - remain at the forefront of efforts to strengthen international standards where necessary, including for market-based finance. Robust, consistently implemented, standards increase the resilience of the global financial system and ensure a level playing field across jurisdictions — this promotes financial stability, financial openness and efficiency. As host of a global financial centre, the United Kingdom also depends upon other jurisdictions implementing robust standards.

4. Supervise firms to promote their safety and soundness to financial and operational risks (including cyber risk) and in the case of insurers, also to protect insurance policyholders. A forward-looking, judgement-based supervisory approach ensures prompt, corrective actions are taken where needed. Effective co-operation and information sharing with other jurisdictions helps supervisors to gauge and manage risks for global financial firms. Strong supervision of globally important FMIs that are based, or operate, in the UK reduces systemic risks both in the UK and at the global level.

5. Ensure banks’ resilience is used effectively in times of stress. The Bank aims to ensure that banks can draw on their capital and liquidity buffers, as necessary, to allow them to cushion shocks and maintain the provision of financial services to the real economy. Some buffers are intended to be ‘countercyclical’; as risks grow, the buffers will increase. If and when risks crystallise, buffers are made available for banks to draw down so they can absorb shocks without disrupting services.

6. Stand ready to provide liquidity to eligible UK firms to reduce the cost of disruption to critical financial services, particularly during periods of heightened uncertainty or market dysfunction. In some cases, banks’ liquidity buffers may not be sufficient to absorb the full impact of a stress. It would not be realistic or efficient to expect UK banks and other financial intermediaries to self-insure against every conceivable shock. The Bank therefore stands ready to use its existing liquidity toolkit, alongside any future tools that are developed (see para (14) on readying the Bank’s balance sheet policy toolkit for the future), to provide liquidity to eligible counterparties by offering to swap high-quality but less liquid collateral for more liquid assets, with an appropriate haircut on the collateral.^{footnote [12]} The FPC contributes to the Bank’s reviews of its market facilities, by giving views (periodically and in the event of material developments) on whether the facilities remain fit for purpose from a macroprudential perspective.

7. Seek to ensure that banks, insurance companies and central counterparties (CCPs) are set up so they can fail without severe disruption. The Bank maintains readiness to use its resolution powers to manage failures as needed of individual banks, building societies, CCPs and certain investment firms to mitigate severe disruption to the financial system and wider economy. The Bank’s resolution regime ensures that, should they fail, major firms can remain open and operating, with shareholders and investors bearing losses and the costs of recapitalisation. This helps to preserve financial stability as the critical functions of the firm can continue while an orderly restructuring takes place. Resolution therefore aims to reduce risks to depositors, the financial system, and any residual risk to public funds that could arise due to the failure of a firm, and helps to align the incentives of firms’ shareholders and managers with the broader public interest. In addition, HM Treasury has published a Consultation Paper^{footnote [13]} on proposals for an insurer resolution regime that will provide the Bank with new powers and tools to effectively manage the failure of a major insurer. The Financial Services Compensation Scheme protects individual depositors in the event that a PRA authorised bank, building society or credit union’s financial circumstances are such that it is unable to repay deposits, and insurance policyholders in the event that an insurer is unable or likely to be unable to satisfy protected claims against it (in each case subject to certain limits and conditions).

8. Provide the infrastructure for resilient settlement of the most critical high-value sterling payments and key retail payment systems by enabling them to be settled resiliently and in central bank money through the Real Time Gross Settlement (RTGS) service.

9. Continue to ensure appropriate individual accountability in financial services. The Senior Managers and Certification Regime (SM&CR) for banks, insurers and other authorised persons^{footnote [14]} promotes the safety and soundness of regulated financial services firms and financial stability by ensuring responsibilities are clearly understood. The Bank supports the inclusion of a SM&CR for Financial Market Infrastructures (FMIs) measure as part of the Financial Services and Markets Bill, which allows the government to design and put in place a similar regime for CCPs and central security depositories (CSDs), as well as HMT’s consultation on extending the SM&CR to recognised payments entities and potentially a wider range of payments firms.

b: Continue to identify risks to the economy that could emerge from the UK or global financial system, and take action where necessary

10. Identify and communicate vulnerabilities^{footnote [15]} - in market-based finance and the banking system - to economic and other shocks. The Bank identifies potential risks to financial stability and explains them publicly so that the financial system can be prepared and resilience can be built up. Transparency about risks is essential to strengthen resilience and for plans to be put in place to manage those risks should they crystallise. One important element of this work is the stress testing of banks, insurers and CCPs to potential macroeconomic and market shocks, and to other risks that may not be neatly linked to the financial cycle. These tests aim to ensure the banking system and financial intermediaries can continue to supply credit and other services even in a very severe stress. Another key element is the regular reviews the FPC carries out of risks beyond the core banking sector. The FPC further assesses vulnerabilities in both banks and market-based finance on an ongoing basis.

11. Proactively prepare for emerging risks in the system. A forward-looking approach is required in order to identify and take action in a timely way to reduce risks to the stability of the financial system. Reflecting this, the Bank’s ongoing work recognises the increasing importance of non-bank financial institutions (NBFIs) to the UK economy. The Bank will run an exploratory stress scenario exercise to (i) enhance understanding of the risks to and from NBFIs, and the behaviour of NBFIs and banks in stress, including what drives that behaviour; and (ii) to investigate how these behaviours and market dynamics can amplify shocks in markets and potentially bring about risks to UK financial stability. This will provide useful information on how firms manage risks across the system – information useful to both the participating firms and their regulators, as well as the Bank. The Bank is also undertaking work to develop the framework for operational resilience (for example, cyber risks and increased use of critical third parties). The Bank seeks to ensure that it is prepared with the toolkit, frameworks and capabilities to respond effectively to micro, macro, real economy and operational risks to the financial system.

12. Take action to address systemic risks, including to mitigate financial stability risks from very high levels of private sector debt, which can make the system less resilient and economic growth more fragile. The Bank and its committees have a range of tools available to protect and enhance the stability of the financial system. This includes regulatory, supervisory and resolvability measures, and its banking, balance sheet and infrastructure operations. The FPC can use tools where appropriate to prevent and address unsustainable levels of leverage, debt or credit growth in the financial system. It has specific powers of direction over the PRA and FCA, and the ability to make Recommendations to any other persons, including relevant authorities. This includes the power to make Recommendations to HMT to change the regulatory perimeter to deal with risks, if necessary. In using its tools, the Bank seeks to ensure that the resilience of the financial system can adapt and be used effectively.

13. Maintain the Bank’s commitment to mutual international cooperation. This is needed to ensure a safe and strong financial system as it helps identify and address cross-border risks. The Bank participates in international fora for cross-border regulatory issues (such as developing rigorous common international baseline standards) and has a number of Memoranda of Understanding (MoUs) in place with supervisors in other jurisdictions to enable the effective supervision of firms operating across borders.

14. Ready the Bank’s balance sheet policy toolkit for the future so it can respond to evolving market structures. Over recent years, and in response to events such as the global financial crisis, the economic impact of Covid, and severe repricing of gilts in September 2022 that exposed vulnerabilities in liability-driven investment (LDI) funds, the Bank has needed to design and implement new balance sheet policy tools in order to achieve its mission. The monetary policy toolkit has expanded to include additional tools beyond Bank Rate, including the purchase and subsequent sale of financial assets through quantitative easing. The Bank has also made significant changes to its approach to liquidity insurance since 2008, such that it now offers highly liquid assets (either cash or gilts) over longer terms, against a wider range of assets as collateral, and, where possible at lower cost, through a wide range of facilities. And in September 2022, the Bank undertook temporary and targeted purchases in the gilt market on financial stability grounds. These changes mean that the Bank’s balance sheet is currently, and in steady state is likely to remain, larger and more complex than it was before the global financial crisis. The Bank is undertaking a programme of work to examine important questions about how the tools and facilities interact with each other, whether new tools or facilities are needed, which tools should be deployed and which types of firms should be eligible to use them.

c: Facilitate sustainable innovation in the UK financial system, including to support the changing needs of households and businesses

15. Shape and facilitate the future of payments and settlements. New payment technologies are resulting in changes to the way payments are and can be made – a core function of the financial system. The Bank is in the process of renewing its RTGS service, which will deliver enhanced resilience and support competition and innovation in both wholesale and retail payments.^{footnote [16]} The Bank is also separately examining the possibility of a retail Central Bank Digital Currency (CBDC) for the UK.^{footnote [17]} The Bank also intends to consult on its proposed regulatory framework for systemic stablecoin arrangements, and is expected to receive powers over these entities in 2023. The Bank is supporting innovation in settlement through its work with the FCA and HMT to establish a Financial Market Infrastructure (FMI) Sandbox in 2023. The Sandbox will remove existing regulatory barriers to allow industry to experiment using new technologies, such as distributed ledger technology (DLT), to deliver traditional FMI activities such as trading and settlement. Internationally, the Bank is actively participating in global fora which seek to co-operate and co-ordinate in ensuring that payments innovation can take place safely and sustainably, and is actively contributing to enhancing cross-border payments.

16. Respond to the challenge of climate change, ensuring that the financial system is resilient to climate-related financial risks and supportive of an orderly economy-wide transition to net zero emissions. Following the 2021 Climate Biennial Exploratory Scenario (CBES)^{footnote [18]}, the Bank will continue to work with banks and insurers to improve climate risk management, for example, by disseminating best practice and considering how the financial risks from climate change are reflected in the micro- and macro-prudential capital frameworks. The CBES showed that financial stability risks from climate change should be lower where there is an orderly transition to net zero. Accordingly, the Bank is working domestically and internationally on approaches to support the financial system’s role in the economy’s transition to net zero. This includes the development and eventual adoption of coordinated and decision-useful disclosures, such as those being developed by the International Sustainability Standards Board and the Basel Committee on Banking Supervision, as well as the work being undertaken to develop transition plans.