By Will Bennett, Geoff Coppins, Maighread McCloskey and Danny Walker.
The financial system makes a vital contribution to the UK economy. It enables households and businesses to make payments, borrow, save and invest, and insure against risks. Financial stability means that the financial system as a whole has sufficient resilience in the face of shocks to ensure the reliable provision of these financial services to households and businesses.
This article explains how the Bank works to protect and enhance financial stability in the UK. Given the cost of financial instability and the complexity of the financial system, this work requires a broad set of policies with input from several different bodies inside and outside the Bank of England.
The Financial Policy Committee (FPC) – which has existed for over 10 years now – is the UK’s macroprudential authority and plays a central role in the Bank’s financial stability work. It identifies and monitors systemic risks that threaten the resilience of the UK financial system and takes policy actions to remove or reduce those risks. These actions are often implemented in co-ordination with other regulatory bodies that have responsibilities for different parts of the financial regulatory architecture.
Inside the Bank, the Prudential Regulation Authority (PRA) and the Financial Market Infrastructure Directorate (FMID) also have responsibilities to make specific contributions to UK financial stability through their supervision of the financial firms they regulate. The Bank is the UK’s resolution authority, meaning it is responsible for managing the failure of banks and other financial firms in an orderly way. And the Bank uses its balance sheet, market operations and the provision of critical infrastructure (including the Real-Time Gross Settlement service) to support UK financial stability.
The Bank also works closely with other authorities while seeking to advance its financial stability objective. For example, the Financial Conduct Authority (FCA) is responsible for ensuring financial markets function well, is the conduct regulator for financial companies and financial markets in the UK, and the prudential regulator for some financial firms, including asset managers, consumer credit providers and insurance brokers. And The Pensions Regulator (TPR) is responsible for regulating and overseeing workplace pensions.
Given the UK’s position as a leading international financial centre, the Bank also works closely with its international counterparts and plays a prominent role in relevant international fora, such as the Financial Stability Board and the Basel Committee on Banking Supervision, to ensure the agreement of robust international standards.
1: Introduction
The Bank of England was founded in 1694 to promote the good of the people of the United Kingdom. Its primary objectives – which are set out in legislationfootnote [1] – are to maintain price stability and to protect and enhance the stability of the UK financial system. This article focuses on the work the Bank does to protect and enhance financial stability.
2: What is financial stability?
The UK financial system is a vital part of our economy, supporting the economic activity of households and businesses through the provision of financial services. These services include financing for investment and consumption, deposit and liquidity facilities, long-term saving and investment vehicles, insurance and payment services. The provision of these services relies, in turn, on a complex system of financial markets and market infrastructure, which helps to channel savings through to investment, establishes the prices of assets, facilitates the sharing of risks, and enables liquidity to move to where it is needed.footnote [2]
Financial stability means that the financial system as a whole has sufficient resilience in the face of shocks to ensure the reliable provision of financial services to households and businesses.
Financial stability is a prerequisite for price stability (and vice versa), and together they make an important contribution to economic growth and prosperity. Periods of financial instability can be incredibly damaging. For example, financial crises, like the global financial crisis in 2008, are estimated to leave the people of the UK with a permanent cost worth around £24,000 per person.footnote [3] To maintain financial stability, it is important to reduce the probability that significant disruptions to the provision of vital financial services – such as financial crises – occur and limit their impact when they do.
3: The role of macroprudential policy
Following the global financial crisis, there was a recognition in the UK and in other jurisdictions that focusing separately on price stability and on the resilience of individual firms and markets was not enough to achieve financial stability. By focusing mainly on individual firms, policymakers unwittingly allowed system-wide financial risks to grow unchecked. For example, these system-wide risks could include interconnections between financial institutions that allow shocks to cascade through the system, or the build-up of debt levels that the economy is unable to support when shocks hit.
A broader approach – macroprudential policy – was needed to ensure the resilience and stability of the financial system. A number of changes to the regulatory architecture in the UK were introduced as a result, including the creation of a macroprudential policy regime.footnote [4] Macroprudential policy aims to make the financial system as a whole more resilient, in order to mitigate disruptions in the vital financial services that are necessary for stable economic growth. Microprudential policy – which used to simply be called prudential policy – refers to regulation that aims to make individual financial firms more resilient.
The experience of recent years, including the impact of the Covid pandemic, Russia’s invasion of Ukraine, and stresses in market-based financefootnote [5] including the ‘dash for cash’ in 2020 and the liability-driven investment (LDI) crisis in 2022, show more than ever the importance of macroprudential policy and the ability of the financial system as a whole to remain resilient in the face of global and domestic shocks.
4: The Bank’s work on financial stability
The Bank of England’s financial stability objective is to ‘protect and enhance the stability of the financial system of the United Kingdom’. This is defined by Parliament, through the Bank of England Act 1998. Meeting this objective requires a broad set of policies, including but not limited to macroprudential policy, with input from a number of different bodies inside and outside the Bank of England (Figure 1).
The Bank has three 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. It sets macroprudential policy – ie policies relating to the stability of the UK financial system as a whole, rather than at the level of the individual firm. The FPC also has a secondary objective to support the Government’s economic policy, including its objectives for growth and employment.
- The Prudential Regulation Authority (PRA) is responsible for the microprudential regulation of banks, building societies, credit unions, designated investment firms and insurers. This involves creating and maintaining policies that regulated firms must follow and supervising financial institutions so as to promote their safety and soundness, seeking to minimise the adverse effects that they can have on the stability of the UK financial system. The PRA must take into account financial stability considerations when advancing its general objective to promote the safety and soundness of the firms it regulates. A key principle underlying its approach is that it does not seek to operate a zero-failure regime. It also has an insurance objective to secure an appropriate degree of protection for policyholders, and secondary objectives to facilitate effective competition and the UK economy’s international competitiveness and its growth over the medium to long term, subject to alignment with international standards. The PRA’s most important decisions are taken by the Bank’s Prudential Regulation Committee (PRC).
- The Financial Market Infrastructure Committee (FMIC) has responsibility for exercising the Bank’s functions in relation to financial market infrastructure (FMIs) in a way that advances the Bank’s financial stability objective. The FMIs supervised by the Bank are essential to the smooth and safe operation of the UK financial system. They provide services, like payments, that we use every day. They enable financial market participants to manage their risks. As a global financial centre, the smooth and safe operation of UK FMIs is also vital for international markets. The Bank’s supervision of FMIs supports financial stability by ensuring that their risk-management and resilience frameworks enable them to carry out their vital functions in normal times and during periods of stress. The FMIC has secondary objective to act in a way that facilitates innovation in the provision of FMI services (including in the infrastructure used for that purpose) with a view to improving the quality, efficiency and economy of the services.
In addition to these bodies, several other parts of the Bank contribute to financial stability.
Figure 1: Functions that contribute to financial stability in the UK (a)
Footnotes
- Key: aqua = Bank of England; orange = other regulator; purple = policy area; gold = firms.
- (a) The chart focuses on prudential regulation and supervision. The PRA also regulates and supervises credit unions, building societies and large investment firms. FMID also regulates and supervises payment systems recognised by HM Treasury and central securities depositories. The Bank’s functions as lender of last resort, both extraordinary and non-extraordinary, are divided between the Resolution Directorate and Markets Directorate. The Financial Conduct Authority regulates the conduct of financial services businesses and is supervisor for other firms that do not fall within the scope of the PRA.
The Bank is the resolution authority for the United Kingdom, meaning it is responsible for taking action to manage the failure of certain types of financial institution – a process known as ‘resolution’. Resolution aims to ensure banks and other certain financial institutions can be allowed to fail in an orderly way, so that disruption to the provision of vital services – and so financial stability – is minimised, and with shareholders and investors bearing losses and the costs of recapitalisation. Resolution works 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. As the resolution authority, the Bank decides which resolution tools to use and carries out any resolution.footnote [6]
The Bank is able to use its balance sheet to provide liquidity to eligible UK financial firms to reduce the risk of disruption to critical financial services, including during periods of heightened uncertainty or market dysfunction.footnote [7] The first line of defence against liquidity risk is the buffers of assets that banks and other financial firms hold to absorb shocks or unexpected outflows. But in some cases, those 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 firms to self-insure against all extreme market outcomes. The Bank therefore stands ready to use its existing liquidity toolkit, alongside any future tools that are developed,footnote [8] to provide liquidity to eligible firms by offering to swap high-quality but less liquid collateral for more liquid assets, with an appropriate haircut on the collateral. Such facilities mean firms know that, as long as they are safe and sound (and meet threshold conditions) and have the right type and amount of collateral, they will have access to predictable and reliable sources of liquidity, at a predictable price, both on a day-to-day basis and when they experience or anticipate an interruption to private markets. The facilities are there to be used and are ‘open for business’.
The Bank provides the infrastructure for resilient settlement of the most critical high-value sterling payments and key retail payment systems through the Real-Time Gross Settlement (RTGS) service. RTGS lies at the heart of every retail and wholesale payment in the UK, including those made using Visa, MasterCard and the Faster Payments system. RTGS also supports CHAPS, the UK’s high value payment system, which is used to settle high-value wholesale payments as well as time-critical, lower-value payments like buying or paying a deposit on a property. 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.
Several parts of the Bank work to support sustainable innovation in the UK financial system, including to support the changing needs of households and businesses. New payment technologies are resulting in changes to the way payments are and can be made – a core function of the financial system. For example, the Bank is examining the possibility of a retail central bank digital currency for the UK. The Bank has also taken steps to ensure a ‘safe innovation’ regulatory environment for the development of tokenised assets. In partnership with the FCA, the Bank has set up a Digital Securities Sandbox, enabling market participants to innovate by issuing and trading digital securities in a safe regulatory environment. And it has set out its proposed regulatory framework for new forms of private digital money, such as systemic stablecoin arrangements.
The Bank’s Monetary Policy Committee (MPC) has responsibility for monetary policy, with an objective to maintain price stability. Price stability reduces volatility in the economy, and so supports financial stability. Box A provides more detail on how the FPC and the MPC interact.
The Bank also relies on other UK authorities to meet its responsibilities. For example:
- HM Treasury determines the regulatory framework for the UK financial system and specifies which activities fall within the regulatory perimeter, including which activities should be prudentially regulated by the Bank, PRA or FCA. HM Treasury must also authorise the use of any resolution power which would have implications for public funds.
- The Financial Conduct Authority is responsible for ensuring that financial markets function well, for conduct regulation, and for microprudential regulation of financial services firms not supervised by the PRA, such as asset managers, hedge funds, many broker-dealers and independent financial advisers.
- The Pensions Regulator is responsible for regulating and overseeing workplace pensions, ensuring employers meet their legal obligations, and taking action to protect members’ interests.
The regulatory architecture for financial stability in the UK is summarised in Figure 2.
Figure 2: Regulatory architecture for financial stability in the UK
Footnotes
- Key: Bank of England = orange; statutory committee = purple; other regulator/public sector body = gold; financial intitutions = green.
The Bank’s work to protect and enhance UK financial stability is important globally, as well as domestically, due to the UK’s role as 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. The UK therefore depends upon other jurisdictions implementing robust standards. Similarly, the UK’s institutions and markets must be a source of strength for the global financial system.
Actions of UK authorities to implement robust prudential regulation for firms operating in the UK, and the UK authorities’ contribution to setting global standards, through their participation in groups such as the Financial Stability Board (FSB), the Basel Committee on Banking Supervision (BCBS), the Bank of International Settlements (BIS), and International Organization of Securities Commissions (IOSCO), therefore contribute to international as well as domestic financial stability.
The UK authorities play a prominent role in efforts to strengthen those 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. The Bank also has several Memoranda of Understanding in place with supervisors in other jurisdictions to enable the effective supervision of firms operating across borders.
Further information on how the Bank collectively delivers its financial stability objective is set out in the Bank’s latest Financial Stability Strategy.footnote [9]
Box A: The FPC’s interactions with the MPC
The MPC’s primary objective is price stability and the FPC’s is to contribute to protecting and enhancing UK financial stability (Figure A).footnote [10] Those objectives tend to be complementary – financial stability is a prerequisite for price stability, and vice versa – and both ultimately support economic growth and prosperity.
There are clear benefits from having two separate committees for financial stability and monetary stability. In practice, it allows the FPC and MPC to each focus on the issues and the setting of policy tools that are most relevant for achieving their individual objectives.
But the policy actions at the disposal of one committee to meet its objectives will often affect economic and financial variables relevant to the other. Furthermore, the overlapping nature of many of the transmission channels for both committees’ policy actions means that the interaction between the two can be complex.
The two committees are required, in their respective remits specified by HM Treasury,footnote [11] to explain how they have had regard to the actions of the other Committee in their policymaking. In addition, while their objectives tend to be complementary, there is the potential for policy trade-offs to arise.footnote [12] This box explains how these interactions work in practice.
Figure A: Objectives of the FPC and MPC
How the committees take into account each other’s actions
The FPC sets macroprudential policy to maintain financial stability, but it can have indirect effects on factors that are relevant to price stability. And the MPC’s monetary policy can have indirect effects on financial stability. So both committees take account of analysis from Bank staff of how the other committee’s policies could lead them to adapt their own policy stance.
Circumstances may arise in which attempts to keep inflation at the inflation target could exacerbate the development of imbalances that the FPC may judge to represent a potential risk to financial stability. The MPC’s remit letter makes clear that the FPC’s macroprudential tools are the first line of defence against such risks but in these circumstances the MPC could allow inflation to deviate from the target temporarily consistent with its need to have regard to the policy actions of the FPC. The FPC’s remit letter notes that it should ensure co-ordination between monetary and macroprudential policy and note publicly how it has had regard to monetary policy. There is therefore an obvious need for the two committees to stay abreast of each other’s discussions and deliberations.
There are several formal and informal arrangements that enable information to flow freely between the two committees. The common chair of the two committees and their overlapping membership helps to ensure an understanding of the key issues one Committee is facing in the discussions of the other, in an informal way. When appropriate, the overlapping members provide live updates during the respective policy rounds.
Members of both Committees have full access to all relevant briefing materials produced by Bank of England staff, for both the MPC and FPC, and they are invited to attend each other’s staff briefings.
The members of the FPC who are not on the MPC also get briefed after each MPC forecast round. This is important, because the FPC uses the MPC’s central projections for macroeconomic variables as the baseline for its own assessment of risks to the financial system stemming from the economic outlook (eg the FPC’s forecasts of household debt service ratios and corporate interest coverage ratios are based on the latest Monetary Policy Report forecast for unemployment and income growth).
Similarly, members of the MPC who are not on the FPC get briefed on the FPC’s discussions. Again, this matters because the MPC conditions its forecasts on relevant policy actions that the FPC has announced. One channel through which this takes place is through the MPC’s assessment of the cost and availability of credit, and of the impact that changes in the availability of credit have on economic activity and inflation, for example, if the FPC had reduced the UK countercyclical capital buffer to support lending.
There are also joint meetings on topics of shared interest, in order to ensure a shared understanding of the financial system and how it is affecting the economy, in which they can jointly steer the path for staff analysis and longer-term research.
The interest of the two committees in the Bank’s balance sheet
The Bank of England’s Executive – supported by its Markets Directorate – is responsible for the day-to-day management of the Bank’s balance sheet. However, both the FPC and the MPC have an interest in how the Bank manages the balance sheet, given it can have material implications for financial stability and price stability.footnote [13]
The MPC has decision-making authority for the deployment of instruments and facilities that are varied over time with the primary intention of affecting overall monetary conditions in order to maintain price stability. This includes, for example, the decision-making around quantitative easing and quantitative tightening in recent years. The Bank implements those decisions. The FPC approves the scope and principles which determine the design of balance sheet facilities to ensure they are effective in ensuring the stability of the UK financial system.
The Bank shares information on its balance sheet with both committees. It consults the MPC on prospective changes to the Bank’s balance sheet operations and the design and operation of any new balance sheet facilities, for whatever purpose, in so far as they may have material and/or enduring implications for monetary policy instruments. It consults the FPC on any material changes to its balance sheet facilities intended to reduce financial stability risks.
In times of stress, the FPC can advise the Bank on the crystallisation of financial stability risks, their nature and the channels through which they can threaten UK financial stability (while respecting the fact that the FPC was not established as a crisis management committee). The FPC can recommend that the Bank takes action to address the specific risks to UK financial stability that it identified.footnote [14]
Lessons from the LDI crisis in 2022 and the failure of Silicon Valley Bank UK in 2023
The arrangements supporting the interaction of the two Committees have been put into practice several times in recent years. Two recent case studies help to bring to life how FPC and MPC interaction works in real-world situations.
In September 2022, a fire sale by LDI funds – triggered by a repricing of assets linked to the announcement of changes to UK fiscal policy – led to severe dysfunction in the gilt market.footnote [15] The FPC was briefed on the market dysfunction and noted the risk to financial stability. It recommended that action be taken to address it, and welcomed the Bank’s plans for temporary and targeted purchases in the gilt market on financial stability grounds at an urgent pace. The Bank also took the decision to postpone gilt sales that the MPC had decided to undertake for monetary policy purposes. The MPC was informed of the market operations before they were implemented. The Bank recommenced the gilt sales associated with quantitative tightening less than a month later.
In March 2023, Silicon Valley Bank (SVB) UK faced a rapid deterioration in liquidity and confidence. The Bank determined – in its capacity as resolution authority – that SVB UK was failing or likely to fail and used its resolution powers to sell SVB UK to a private sector purchaser.footnote [16] This resolution action came at the same time as severe stress at several regional banks in the US and there was the potential for a wider loss of confidence in the global banking system and a tightening in financial conditions, including in the UK. Ahead of the MPC’s policy decision taken on 22 March, the FPC shared its analysis of the developments in the global financial system with the MPC. The FPC made clear that it judged that the UK banking system remained resilient, and was well placed to continue supporting the economy in a wide range of economic scenarios, including in a period of higher interest rates. As a result, there was no need for the MPC to take into account financial stability risks, and it proceeded with its policy decision as normal.footnote [17]
Section 2A and 11 of the Bank of England Act 1998.
See the FPC’s publication on operational resilience for more detail on these vital services.
Bank estimates based on the impact of historical financial crises in a sample of advanced economies, reported in Brooke et al (2015), suggest that the average cost of a financial crisis has been 73% of GDP, which translates to a cost of roughly £24,000 per capita if a financial crisis took place in 2024.
See Changes to the Bank of England for more information on the changes that were made to the regulatory architecture in the UK following the crisis.
Market based finance is made up of financial markets (eg, equity, debt, and derivatives markets) and different kinds of investment funds, insurers, intermediaries like broker-dealers, and market infrastructure like central counterparties (CCPs).
See The Bank of England's approach to resolution for more on the Bank’s approach to resolution. HM Treasury has sole responsibility for any decisions involving public funds and as such is responsible for taking any last resort decision to bring a firm into temporary public ownership or to provide equity support with public funds, and for authorising any temporary liquidity support from the Bank via its flexible Resolution Liquidity Framework. The Financial Services Compensation Scheme (FSCS), the UK depositor protection scheme, also has a role in protecting the customers of failed firms.
The Bank’s eligibility criteria are set out at Information for applicants.
This includes ongoing work to develop a new backstop non-bank financial institution (NBFI) lending tool (the ‘Contingent NBFI Repo Facility’ (CNRF)). As a contingent facility, the CNRF would be activated at the Bank’s discretion in episodes of severe gilt market dysfunction that threaten UK financial stability, to lend cash, against gilt collateral, to eligible insurance companies, pension funds and liability-driven investment funds for a short lending term.
Reflecting the fact that many parts of the Bank contribute to the financial stability objective, the Court of Directors of the Bank has a statutory duty to determine this Strategy, review it at least every three years, and revise it if necessary. In practice, Court has delegated the review of the strategy to the FPC – as permitted by the Bank of England Act 1998 – but Court retains ultimate responsibility for the strategy.
They share a common secondary objective to support the Government’s economic policy. The secondary objective is ‘subject to’ the primary.
HM Treasury specifics these matters to the FPC and the MPC in remit letters issued to them pursuant to s.9D and 12 of the Bank of England Act 1998 respectively.
See The interaction of the FPC and the MPC for some examples of how monetary and macroprudential policy could interact with one another.
See Governance of the Bank of England's balance sheet: principles of engagement for a full explanation of the governance of the Bank’s balance sheet.
The FPC may make recommendations to the Bank relating to the provision by the Bank of collective financial assistance to financial institutions or to addressing market dysfunction that threatens UK financial stability. But it may not make recommendations relating to provision of financial assistance to a particular institution. The Executive is not obliged to consult the Committee on liquidity insurance operations relating to a particular institution.
See this 5 October 2022 letter, this 18 October 2022 letter, and this recent blog post for further information on the causes of the crisis.
See Monetary Policy Summary and minutes of the Monetary Policy Committee, March 2023 for details.