How can the financial system be made more stable?
Here at the Bank of England it’s our job to maintain financial stability. We do this through two bodies: the Financial Policy Committee (FPC) and the Prudential Regulation Authority (PRA).
The FPC are the mechanics of the financial system, working to keep everything moving smoothly. They identify risks and flaws in the financial system, assessing how bad they might get and acting to remove or reduce them.
The PRA are the safety engineers who regulate and oversee financial institutions.
There are three elements which contribute to financial stability:
- A reliable mechanism must be built with a strong and well-designed structure. Financial institutions are expected to meet very high standards of resilience. This is achieved by setting tough regulations which are checked by the PRA. New rules aim to encourage honest behaviour and limit excessive risk-taking with other people’s money.
- The ability to change gears is necessary when the road gets tougher. Financial institutions must be able to adapt their level of resilience to new risks that might be developing. This is why banks go through stress tests every year to make sure they have enough financial resources (called capital) to provide financial services in bad times as well as good.
- A car’s shock absorbers reduce the impact of bumps in the road. The FPC has developed tools to dampen and contain shocks when they occur so that they do not get worse. For example, we have put limits on the amount of mortgages lenders can approve that are 4.5 times or more the size of a borrower’s income. This helps us reduce the risks from household borrowing should the economy suffer a downturn.