Picking what matters – speech by Nathanaël Benjamin

Speech

Introduction

Thank you for inviting me to speak today, it’s a pleasure to be with you.

Part of our role at the Bank of England is to ensure the UK is a stable and reliable place to do business – even in turbulent times, supporting competitiveness, growth, and economic welfare.

And we live in turbulent times.

So the question for us is: in a risky world, with a financial system and economic needs that are evolving constantly, how do we pick what to worry about and act on, and even more importantly, what not to worry about?

We’re developing our financial policy framework to help us do just that. It is an ambitious and pioneering endeavour. But in a world where shocks could come from all sorts of corners, we must be deliberate and selective in our focus.

So first I’ll outline our direction of travel on this, and then I’ll illustrate what that means with a couple of examples of policy judgments we’re considering this year. The heart of this framework development – and my speech today – is to link everything we do back to why we do it. Because financial stability is only a means to an end – not an end in itself. We need financial stability because it’s indispensable to the economic welfare of the people of the UK.

This is not a new idea. The Bank of England was founded in 1694 with a mission to promote the good of the people of the UK. At the time that meant funding the war against the French, but that’s a different story...

Our mission of promoting the good of the people of the UK is timeless, it still endures today, with monetary and financial stability at the core.

Connecting explicitly to that ultimate goal of economic welfare is what we seek to do, systematically, as a mechanism to prioritise and guide financial policy.

In doing so, the critical role the financial system plays in providing services to households and businesses takes centre stage.^{footnote [1]} The financial system contributes to welfare through supporting economic activity and resolving frictions that would otherwise exist in its absence. For example, it matches borrowers and savers to support investment, insures against risks so that households can spend their money instead of having to set aside large precautionary buffers against potential losses, provides payments and liquidity services to enable spending to take place, etc. Disruptions in these services have large and persistent economic costs.^{footnote [2]} So a stable financial system, which can fulfil its fundamental role in a range of environments, is crucial.

Our mindset is to think about financial policy in a way that considers financial stability and economic activity together.

By financial policy I mean policy to ensure vital services are provided by the financial system, as a whole, in both good and bad times. That includes deciding whether to use our policy tools, and if so, which ones. Unlike monetary policy, we require a very broad toolkit because financial instability can take many forms and arise from many corners. We can make recommendations to virtually any UK authority, about the resilience of (or frictions facing) different actors in the financial sector or the economy, hence the importance of how we decide to act – the topic of my speech today. We can use our communications as a tool to flag issues so that market participants deal with them themselves. And we have tools to intervene when shocks hit, for example with our balance sheet, if we judge that is necessary to maintain stability.

A key judgment is whether economic stability and welfare are better served in the long term by building resilience in advance, in normal times, or by having the right tools to step in if shocks happen. We can’t build resilience in advance of all shocks as we can’t predict all future crises. Trying to do so would lead to what some have called the “stability of the graveyard”, choking long-term growth, and therefore weakening resilience. So when assessing risks, building resilience, or intervening in the event of a shock, we must be proportionate, selective, and deliberate, mindful of efficiency, productivity, and competitiveness. The financial stability framework we are developing helps us do all that, and focusses on the provision of vital services to the real economy, in a way that is agnostic about which bit of the financial sector does it.

Before turning to our plans, let me touch on important context and background on the Financial Policy Committee (FPC) and developments in the financial system.

Financial stability after the Global Financial Crisis and today

The financial stability framework we have today emerged from the Global Financial Crisis (GFC). The cost of the crisis was staggering. GDP bottomed out in May 2009, 11 per cent below the pre-crisis trend. The crisis caused a large diversion of public funds globally towards plugging all sorts of holes and away from long-term productive investment. It caused significant economic hardship, with over a million more unemployed people and a sharp rise in the number of people losing their homes. There was a very persistent slowdown: average UK growth in the 15 years before 2008 was just under 3 per cent, while in the 15 years since, it barely exceeded 1 per cent. This slowdown is largely accounted for by very weak productivity growth, which has been even lower in the UK than in its peers, and which itself reflected low investment.^{footnote [3]} While pre-crisis growth may not have been sustainable, scarring from the crisis played a big part in weak growth thereafter. So it is unsurprising that the GFC marked a regime change in financial policy.

The post-GFC reform agenda included several important elements: 

• Strengthening banks so they support the economy when shocks hit, rather than amplify them as in the GFC.
• A new and clearer delegation of responsibility for financial stability policy, including creating the Prudential Regulation Authority to supervise UK banks and insurers within the central bank, reuniting bank regulation and supervision with central bank balance sheet operations.
• Establishing a new macroprudential policy body – the Bank of England’s FPC – recognising that the safety and soundness of individual financial players was not enough to ensure the overall stability of the system.^{footnote [4]} Increasingly the sum of the parts doesn’t add up to the full picture. So the FPC’s objectives relate to the financial system as a whole, which I will turn to shortly.

Although we continue to push forward reforms to make the banking regulatory regime as effective and proportionate as possible,^{footnote [5]} it has undoubtedly been successful in reducing the scale of the too-big-to-fail problem,^{footnote [6]} and in making the banking system more resilient and able to support households and businesses. This was clear in stress test results and real-world stresses, including the pandemic, when the banking sector was able to continue lending and offer households with a mortgage some much-needed financial oxygen.^{footnote [7]} That’s exactly why we need strong lenders, so they can help not only in good times, but also in bad times.

But the system has evolved a lot, with rapid growth and change in the non-bank sector, introducing new vulnerabilities. These system-wide issues include excessive liquidity and maturity mismatches, extreme leverage, exacerbated by concentrated or correlated positions and interconnectedness.^{footnote [8]} These vulnerabilities have often amplified recent shocks in the last few years, and ongoing policy work by the FPC and Financial Stability Board aims to mitigate them.^{footnote [9]}

The financial system is also evolving in other ways, with fast digitalisation and the adoption of AI, and to respond to climate change and the net zero transition. These developments are potentially transformative, evolving how vital services are provided, creating new opportunities and new operational risks. Geopolitical tensions, higher long-term interest rates, and central bank balance sheet normalisation have also changed the landscape.

I am sure many of these developments are on your minds too. For us, they have consequences for the FPC, which was set up more than ten years ago to tackle the challenges of the day. Since then, the FPC has built up a good experience of operating in practice, and challenges are constantly evolving. So it is the right moment to step back and continue to develop our analytical framework, consider how we operate, and the analytical support needed. So that we spend our time wisely and are in the best position to tackle the growing number of challenges for the next ten years. In a rapidly evolving world, it is more important than ever that our framework guides us to focus on the risks that really matter for economic welfare. In a world where it’s far too easy to lose sight of the wood for the trees, and too tempting to worry about everything. We can’t fall into that trap.

Developing the framework

So, what does this mean for our framework and how we spend our time?

The FPC’s primary task is to identify, monitor, and take action to remove or reduce, systemic risks, or, put simply, things that can disrupt the efficient provision of vital financial services. This involves three different operating modes:

• Identifying risk: As noted, the financial system is constantly evolving. So the first step is to identify if changes pose material threats to the provision of vital services. Recent FPC work in this category includes assessing risks from climate change, increasing concentration of critical third-party suppliers, and AI. The intelligence we gather from market participants like yourselves is also an essential part of this process.
• Taking action: If a systemic risk is identified, the FPC decides when and how to act. This involves supporting actions by other authorities or taking direct action itself. The nature of that action depends on the nature of the risk and can include tackling the risk at source, building resilience to mitigate the consequences of the risk crystallising, changing behaviours through our communications, or readying our toolkit so that we’re prepared to intervene if necessary. When designing policy, we consider the costs of acting and check for adverse impacts on long-term growth.
• Monitoring: If a risk is not currently systemic or is already being mitigated, the FPC shifts to monitoring mode.

So the rules of thumb for prioritisation go something like: is an issue systemic or not, both structurally and under plausible scenarios? Is it being largely addressed by other authorities? More broadly, is mitigation already underway? Have things changed materially? This framework helps organise and prioritise the FPC’s work to identify and mitigate systemic risks, thereby reducing the inefficient frictions they cause, and by doing so raising economic welfare.

Because the goal is not just to ensure vital financial services are not disrupted when shocks hit. It is also to ensure that in normal times the financial system helps welfare by allocating resources and sharing risks efficiently. I will come back to this later.

This way of thinking about stability and economic welfare together is not new to the FPC; it is engrained in our thinking. Every quarter, we worry as much about insufficient lending as we do about unaffordable lending. And when shocks have hit, we have not hesitated to drop banks’ countercyclical capital buffers immediately to ensure they use all the firepower needed to support people and businesses through challenging times. But while this mindset is longstanding, we are now investing in our analytical framework to better support our judgments, consistently and systematically balancing building resilience and growth, keeping in step with a changing world.

I will now discuss how we intend to develop our framework in two critical areas supporting the FPC’s judgments: scenario analysis and policy analysis.

Scenario analysis is at the heart of our risk assessment. The financial system is a complex network of institutions and markets, each responding to shocks on a daily basis. Scenario analysis is essential to understand how different shocks – financial (like interest rates or exchange rate shocks) or real economy (like shutdowns due to the pandemic) – can expose financial system vulnerabilities and threaten stability.

Ultimately, our scenario analysis aims to understand how shocks impact the real economy through the provision of vital services. So, our starting point is institutions interacting directly with households and businesses – like banks, insurers, or other providers of direct services such as derivatives to hedge companies’ input costs.

We need to understand how those institutions behave and where the vulnerabilities in business models lie. In doing so, it is important to be as consistent as possible, assessing the impact of any scenarios coherently. For example, if banks and insurers both access the same type of funding to support their lending and insurance activities, both should be affected similarly if a shock hits that type of funding. Equally, if both respond in a similar way to a shock, we need the consequences of that response to be consistent. Same risk, same regulatory outcome.

This brings us onto dependencies on markets and other institutions that do not interact with households and businesses, but which are nevertheless essential to the efficient provision of services to them. Banks, for example, rely on both debt and equity markets to support their lending activities; pension funds and insurance companies have for a long time relied on long-term gilt markets to match the duration and longevity risks inherent in providing stable income in retirement, through defined-benefit schemes and annuities; and most institutions rely on investment banks and dealers to enable them to manage their risks more efficiently, including through liquidity facilities and derivatives.

Through these dependencies, the financial system can share risks and be more efficient. But it also means that vulnerabilities at the core of the financial system – the markets and institutions on which financial services rely – are essential to understand through scenario analysis. The 2020 “dash for cash” highlighted how these weaknesses can amplify shocks. So we have to understand how markets work, which institutions are important for their functioning, how they interact, the demands placed on markets – not only by direct service providers to the real economy but also by other actors such as hedge funds or principal trading firms – and the way in which all this impacts market pricing.

It is not an easy task. But only by carefully mapping behaviours, vulnerabilities, dependencies and interactions across the financial system, can we choose meaningful scenarios and compare outcomes across risks and sectors. This is why we did things like our recent system-wide exploratory scenario exercise (SWES), to understand how core UK markets, and their ecosystem, respond to shocks – and how best to prepare for those.

Our framework, outlined more fully in a paper that we will publish shortly, can be developed with scenario analysis in mind:

• We can better ground our analysis in the “why this matters”, by mapping scenario analysis more routinely to impacts on service provision and the real economy. This will ensure we remain focused on the purpose of financial stability and help us prioritise more effectively.
• We can enhance our system-wide scenario analysis by considering financial system interlinkages. This includes improving system-wide models, building desktop capabilities to quantify financial market stress scenarios as seen in the dash-for-cash, or the scenario developed in the SWES. We can also apply the industry participation model used in the SWES to better understand other parts of the financial system. As I’ve said before, we’re big fans of stress testing and system-wide scenario analysis. That enables us to spot the problems and take actions in good times, so we are prepared for bad times. We will use these to join the dots gradually to explore, bring to light, and map out systemic connections and how they affect vital services and the real economy.
• We can extract more information from data to improve monitoring of vulnerabilities, building on recent strides in data analytics.^{footnote [10]} This will help us prioritise issues and judge what is and is not systemic.

Our analytical framework will help evaluating policy actions and choosing between alternatives, weighing up both benefits and costs. And never choosing a policy which we think will lower long-term growth.

The benefits of our interventions can relate to borrowers being resilient, in a way that supports their contribution to the economy (e.g. via consumption or production). The nature of policy costs can relate to the cost of compliance, or to the extent to which policies can result in more expensive financial services in good times. The FPC has quantified the benefits and costs in its assessment of banking system capital requirements^{footnote [11]} and mortgage market interventions, for example.^{footnote [12]}

A key challenge is measuring costs and benefits in common units for comparison, and understanding how they net off. As I said, the ultimate “why” of financial stability is economic welfare. But as welfare is notoriously hard to measure, policy analyses often use GDP as a proxy. One way to enhance the framework, facilitate policy analysis, and improve our understanding more generally is to investigate metrics linking the assessments of financial stability and economic welfare, and to be clear about what financial stability conditions look and feel like in practice for any given vital service. For example, to gauge how banks can lend to businesses and households even as shocks hit, or how developments in household indebtedness won’t lead to a housing boom and bust. Such policy modelling capability will help us gauge the full implications of a range of policy interventions, such as countercyclical bank capital buffers, housing tools, or even gilt market measures.

But we must remain humble about our ability to identify all issues before they occur. The financial system is complex, and we aim to build resilience only against severe but plausible scenarios, not against all scenarios.

This complexity is why financial policy is underpinned by baseline capital and liquidity standards to cover the foundations of stability. And it is why ex-post intervention tools are also an important part of our toolkit. For example, the Bank recently developed a Contingent Non-bank financial institution Repo Facility to lend to eligible non-banks during episodes of severe gilt market dysfunction. It is a natural extension of a long history of lender-of-last resort operations^{footnote [13]}, and an evolution of our toolkit in step with the changing landscape of who does what within the financial system.

So that is our direction of travel for our analytical framework to support financial policy.

So what, you might ask.

Let me bring this to life by illustrating practical implications for areas of potential near-term policy development.

Financial stability, growth, and welfare

The Chancellor’s November 2024 FPC Remit letter asked the FPC to “assess and identify areas where there is potential to increase the ability of the financial system to contribute to sustainable economic growth without undermining financial stability”.^{footnote [14]}  

This request reflects the financial system’s role in underpinning sustainable growth and contributing to economic welfare. And the question is how this contribution can be enhanced in a sustainable way – rightly hinting at the distinction between short-lived growth that causes unsustainable asset bubbles which then burst, destabilise, and hit long-term growth, vs. sustainable growth that boosts long-run economic productivity, thereby strengthening the resilience of the economy. 

This same mindset underpins the analytical framework we are developing.

Action to support growth 

The financial sector plays a crucial role in supporting growth through its role in allocating capital efficiently for productive investment and providing vital services to its customers so they can contribute to the economy. It drives innovation in the real economy, and adopts new technologies itself to enhance productivity. The most important thing financial regulators can do for growth is to ensure a stable financial system. But smart policies and regulation also form a conducive environment for the safe adoption of new innovative technologies, such as Distributed Ledger Technology (DLT), AI, and cloud computing. Another plank of growth is the safe openness and competitiveness of the financial sector, allowing UK firms to compete on a level playing field with foreign firms, both domestically and internationally, and ensuring the UK is an attractive location for financial services. Regulators ensure interventions are responsive, proportionate and not overly burdensome, and tailored to UK-specific circumstances. The Bank of England is considering all of that, across its different functions.For the PRA, this responsibility is enshrined in its secondary objective to support growth and competitiveness of the UK financial sector. My PRA colleagues have outlined a range of initiatives to improve regulatory efficiency, which I won’t cover here today.

To reduce burdens, the latest example from the FPC is reducing the frequency of bank capital stress tests from annually to every second year. Because we judged banks are now strong enough that we can get the same degree of reassurance but in a less burdensome way. This should free up a considerable amount of resources in banks, which they can direct where needed.

Going forward, the FPC’s starting point in identifying potential for greater contribution to growth by the financial sector is to look for its closest interactions with the real economy. So we are assessing the supply and allocation of finance and services to businesses, such as SMEs looking to scale up. And we are working with the government and other stakeholders to consider ways to unlock the potential investment in long-term productive UK assets. We are also reviewing our housing market policies, given the vital role of that market in people’s lives, to ensure our policies are proportionate and efficient, but without reducing overall resilience.

Let me step through a few of those examples. If you have views on how the financial system could better support long-term UK growth, do get in touch – we would love to hear from you.

SMEs 

Suboptimal access to finance can hinder growth. A 2024 article by Bank of England Staff found that over 20% of SMEs believed they had underinvested over the previous three years.^{footnote [15]} Commonly reported reasons for this included the current economic environment, an inability to self-fund from cash reserves, inability to access finance on reasonable terms, and collateral requirements. Around 70% of businesses preferred slower growth over taking on debt, revealing a general theme of aversion to external finance. Now clearly some of this might be because debt, although still available to them, has become more expensive. But SMEs globally face structural challenges in accessing external finance for several reasons, including limited credit histories, a lack of collateral, and the risk associated with lending to smaller firms. So reducing barriers to accessing both equity and debt finance could decrease this aversion, and help SMEs scale up and invest in their productive potential. This is important because SMEs employ more than half of the UK’s private sector workforce, so improving SME productivity can support the economic welfare and resilience of many households.

Alongside HM Treasury, we are investigating ways to reduce these barriers. We aim to build on the work of the British Business Bank who are already active in supporting access to finance through the government-backed loan growth scheme and the equity Angel Co-Fund. However, further deepening of UK capital markets could help increase equity financing for fast-growing SMEs, especially to invest in productivity improvements, e.g. AI, data science, or broader technological advances that support automation. So one question that is reasonable to ask is: is it worth exploring the merit of public-private partnerships between private equity and the public sector to invest in SMEs looking to scale up? We have outlined in the past the risks arising from the private finance ecosystem, but there are big opportunities too. The current environment offers a unique opportunity for the private equity industry to demonstrate the point it often makes that it tends to stick around in challenging times more than other forms of finance. This matters for both financial stability and growth, for the same reason.

Long-term capital 

Let’s turn to long-term capital, which is key to strengthen the economy’s productive capacity, by financing new infrastructure, data centres, and advancing technology. UK authorities are working to remove barriers to insurers and pension funds making long-term productive investments in the UK, e.g. via proposed reforms to reduce fragmentation in the defined contribution pension market and create deeper asset pools.^{footnote [16]} This will unlock precious firepower.

Prudential regulation also plays a role in maximising the flow and efficient allocation of capital to productive investment. As the life insurance sector absorbs more and more of the defined benefit pension sector – flows of £50bn a year are forecast – the impact of their investment choices on the wider economy increases. Reforms to Solvency UK insurance regulation create capacity for life insurers to increase productive, long-term investments in the UK.^{footnote [17]} In the view of the insurance industry, Solvency UK reforms should enable insurance firms to invest at least £100 billion in UK productive assets over the next decade.^{footnote [18]}

We haven’t yet seen substantive evidence of this additional investment in UK assets materialising post completion of the regulatory reforms. Success depends on the decisions of pension funds and insurers themselves, their investment management policies, and the availability of appropriate investment opportunities. The Bank will continue to work constructively with industry and HMT to explore collectively how UK productive investments can be structured to meet the “Matching Adjustment” eligibility criteria and thereby be used to their fullest extent.^{footnote [19]} It is very important that this happens.

Housing tools

My final example is our work on the housing market. The UK housing market underpins daily life for most people in the UK. As part of that, the effective functioning of the mortgage market is critically important – enabling people to purchase a home to live in or to rent, move home and region for work or family reasons, and build up wealth. This supports economic welfare.

But high levels of household debt can pose financial stability risks.^{footnote [20]}

The FPC has a range of tools to mitigate these risks including capital requirements and borrower-based tools. In 2014, the FPC introduced a loan-to-income (LTI) flow limit, capping at 15% the proportion of mortgages extended at LTI ratios of 4.5 or greater. This was complemented by an Affordability Test Recommendation^{footnote [21]} and built on the FCA’s Mortgage Code of Business lending guidelines. The FPC reviewed these measures – in their “monitoring” mode – and removed the Affordability Test in 2022, finding it had similar effects as the LTI flow limit.^{footnote [22]}

These measures have effectively limited financial stability risks from household indebtedness – in aggregate, households remained resilient through the recent severe shocks we’ve faced. That was no accident.

But in practice, although there is plenty of aggregate headroom within the 15% limit^{footnote [23]} – some lenders do very little high-LTI lending, others run closer to the limit (though acting cautiously when approaching it). For some lenders, FPC policy has been a constraint at times. So, we’re discussing this with the industry to understand what could be done to help ensure more of the aggregate headroom is used to give creditworthy households access to mortgages.

More broadly, the main barrier to homeownership is people’s ability to assemble a deposit, given how high house prices are compared to incomes. There are households who have paid their rents on the dot for many years despite steep rises in rents, with a spotless credit history, stable forward-looking employment prospects, and the buffer to take on potential additional costs of mortgaging and owning a home. Yet they are unable to assemble a deposit while paying rent. So they face big barriers to buying a home – even though they are creditworthy with a low risk of not being able to repay their mortgage. A natural question therefore is: can more be done to help creditworthy households get on the housing ladder? Are there circumstances where the higher risk of providing high-LTV mortgages to these types of households can be mitigated by demonstrating a lower probability of default? Those questions embody the FPC’s mindset of considering economic welfare and financial stability together, focussing on the provision of vital financial services.

Conclusion

At the current juncture, in a risky world, with a financial system and economic needs that are evolving constantly, it is important that we develop our framework to help us pick what to worry about and act on, and what not to worry about. And in doing so, we must focus on the “why”, which is economic welfare in the UK. Our framework will help us do just that, by investing in system-wide scenario and policy analysis – with an eye to ensuring the financial sector plays its fundamental role in supporting the economy.

We are playing our part – working with the financial system to help spot and unlock frictions, supporting productive finance, and ensuring regulation is efficient, and much more. In all this, I want us to be known for several things. First, people need to feel they can come and talk to us, we can have a conversation. Second, we won’t kick up a fuss for nothing, we are proportionate. But when we do, we know what we’re talking about, and we mean it. And finally, we want to be predictable, we won’t move the goalposts. In turn, we can provide firms, customers, and counterparties with reassurance that they can do business safely and with confidence, and play their part in supporting growth.

The current juncture represents a terrific opportunity for the UK. And it is down to all of us to seize it.

Thank you.

I’d like to thank Matt Waldron, Oliver Bush, Niamh Reynolds, Nicola Anderson, Richard Button, Colm Manning, Marek Rojicek, Katie Fortune, Christopher Goodspeed, Alan Sheppard, Lee Foulger, David Bailey, Rashmi Harimohan, Sarah Ashley, Grellan McGrath, Vicky White, Laurienne Sherriff, Sophie Stone, and Martin Arrowsmith for their assistance in preparing these remarks.