The UK financial system remains highly resilient. But strong and stable macroeconomic and financial conditions have encouraged financial institutions to expand further their business activities and to extend their risk-taking, including through leveraged corporate lending, and the compensation for bearing credit risk is at very low levels. That has increased the vulnerability of the system as a whole to an abrupt change in conditions. Financial innovation and the growing use of credit risk transfer markets have increased the risk-bearing capacity of the system – but also bring some risks. Recent developments in the US sub-prime mortgage market have highlighted how credit risk assessment can be impaired in these markets and how participants can be hit by sharp reductions in market liquidity. Similar problems in a more significant market, such as corporate credit, could have more serious consequences if credit quality were to deteriorate. It is important that participants in these markets are alert to these risks and that firms’ stress testing takes them into account.
Press release