Cooperation, higher geopolitical tensions also create an environment of heightened risk of cyber attacks. Financial markets globally have absorbed recent significant news in an orderly way, and core markets have continued to function well following a short-lived period of volatility in August. And as the FPC said in October, there was evidence in August of deleveraging amplifying price moves, and while it did not spill over to the markets, it might have done so had subsequent economic news not been positive. Government bond yields have increased, but valuations across several risky asset prices have risen further, leaving risk premia even closer to historical lows. Despite the challenges facing the global risk environment, we continue to judge that valuations and risk premia are vulnerable to a sharp correction, which could adversely affect the cost and availability of credit to UK households and businesses.
Second, we continue to judge that the UK household and corporate sectors are expected to remain resilient in aggregate, although many households and businesses remain under pressure from the higher cost of living and higher interest rates. The outlook for mortgage borrower resilience has improved in line with the domestic economic outlook. For example, while the aggregate mortgage debt servicing ratio is expected to rise, it does so modestly, and the share of households with high debt servicing burdens has remained relatively low. In addition, while around half of mortgage holders could experience greater borrowing costs over the next three years as they refinance onto higher rates since 2021, a quarter of borrowers are expected to benefit from lower rates during that period. Turning to corporates, debt market issuance has continued to be strong. However, risks remain among small and medium-sized enterprises and some highly leveraged corporate borrowers. These highly leveraged businesses are likely to face challenges from higher rates as they refinance, which would be greater if investor risk appetite deteriorated or if interest rates remain higher for longer than markets expect.
Third, the UK banking system is well capitalized, maintains high levels of liquidity, and asset quality remains strong. We judge that even if economic, financial, and business conditions were to materially worsen, the banking system has the capacity to support UK households and businesses. The results of the 2024 desk-based stress test published today support this judgment. This shows that the UK banking system is resilient in aggregate to two hypothetical severe macroeconomic scenarios: one is a global supply shock that drives higher inflation and interest rates; the other, a global demand shock that results in lower inflation and interest rates. In both, the system can continue to meet the demand for credit from creditworthy households and businesses. This evidence has supported the FPC's decision today to maintain the UK countercyclical capital buffer rate at 2%, its neutral setting. We have also today set out our updated approach to stress testing the banking system. We are moving from an annual to biannual frequency for our main bank capital stress test, where in the intervening years we expect to assess the risks to and the resilience of the banking sector through desk-based stress tests and exploratory exercises. This change in approach will ensure the burden on participating banks is proportionate and supportive of the sector's competitiveness and growth, without compromising our assessment of the stability of the banking system. We will undertake our next bank capital stress test next year in 2025.
Fourth, long-standing vulnerabilities in market-based finance that we have previously identified remain a concern. These vulnerabilities, such as increased leverage positions amongst hedge funds, if crystallized, could amplify market volatility significantly, including by interacting with potential sharp price corrections in financial markets. Several market stress episodes demonstrate the importance of reducing the risks posed by high leverage, under-margining, and margin procyclicality in core markets, including through the Financial Stability Board's international work program. In our June Financial Stability Report, we highlighted the vulnerabilities associated with the global private equity sector, which plays a significant role in financing UK businesses. Today, we have published analysis on emerging vulnerabilities at the intersection of the private equity and life insurance sectors, including through private equity-backed reinsurers offering funded reinsurance. We support the regulatory actions by the Prudential Regulation Authority to mitigate risks to UK life insurers and also support international work to address the buildup of these risks more broadly. Today, we have also published the conclusions of our System-Wide Exploratory Scenario, exploring how the UK financial system as a whole would respond to a market shock. This has been the first exercise of its kind and has been world-leading in its approach, and we are grateful to everyone that has participated in this important exercise. The SES has improved our understanding of behaviors of banks and non-bank financial institutions during stressed market conditions and revealed several mismatches and expectations among market participants. The results illustrate that actions taken by authorities and market participants following recent stresses, for example on LDI funds, have helped to increase gilt market resilience. They also highlight a number of remaining risks and vulnerabilities that will be important to address, including the importance of the resilience of the gilt repo and the corporate bond markets. All financial market participants should factor system-wide dynamics and the lessons from this exercise into their internal risk management and stress testing. I would also note that system-wide stress testing has proved to be an effective tool for improving our collective understanding of those system-level vulnerabilities. It is very deliberately a flow test which uses the reactions of participants themselves to get to the points of vulnerability. The approach is to lay out the picture so that we can then decide what to do on the basis of a better understanding of the nature of the issue. We will continue to invest in our capabilities in this area for surveillance and risk assessment, and there are potential benefits to the broader international community of exploring such system-wide exercises. So let me conclude: while the central outlook is for growth in the UK to remain steady, global risks are high and the outlook has become more uncertain and riskier, and our focus remains on maintaining financial stability by supporting the resilience of the financial system and its ability to support economic growth. And now Sarah, Sam, and I will be very happy to take your questions. Thank you.
Great. Who would like to go first? Go ahead.
Kina Mordo from The Guardian. Do you have any concerns about the Labour government's recent messaging, particularly the fact that they seem to be encouraging risk-taking in the financial sector and criticizing the effect of reforms introduced after the 2008 financial crisis? And has any of this been taken into consideration when you've been assessing how banks or the shadow banking sector might end up posing more risks to financial stability in the coming years? Thanks.
Well, let me go back to the remarks I made right at the beginning, because this is a very important question you raise. So we are obviously very supportive of growth, and I'd refer you back to the speech I made at the Mansion House, which really spent its whole time focusing on this question. But it is very important to emphasize, as I did, that there is no trade-off between growth and financial stability. Financial stability is the bedrock of having an economy that supports households and businesses in which growth can take place and in which competitiveness can be put into effect and demonstrated. Now, there are of course all sorts of choices about policies once we have financial stability and once we can be assured of maintaining it, and there are important choices that we make all the time, and illustrated in the material that we've released today about exactly what we have to do to ensure financial stability. So let me give you an example, and Sam and Sarah might want to come in at this point: switching from doing a stress test every year to doing one every two years. It's a decision we can now take because we have a banking system that is stable and has demonstrated that stability for a period of time and which we believe to be resilient going forwards. So we can take that decision, and that decision is in the interests of everybody. It will support a banking system which has sort of lower overhead costs attached to it. So those are the sorts of decisions we can take, but we can only take those decisions if we're in a world of financial stability.
Perhaps I could add briefly, Andrew. I think the messaging is consistent with the instruction we have from Parliament in the form of a new objective on competitiveness and growth, but that is a secondary objective. So we're not being invited or instructed to in any way put financial stability or safety and soundness at risk. The question is, can we deliver that objective in a more efficient and proportionate way that's more helpful for competitiveness and growth? And I think Andrew gives a very good example. We think we can now deliver what we've been getting through stress testing by doing the big, heavy, burdensome test every other year because of the amount of resilience that's been built up since we started. And if I might add, one of the things that we could also do, and we also have done, is understand how the financial services sector, through the activities it provides, can support growth. So some of the things as the FPC that we've done recently include working with the FCA and the Treasury on supporting productive finance through the long-term asset work that we've done. We've sought to improve the ability of the financial services system to use third-party providers like cloud in a safe way. We've supported innovation in money and payments, and we've sought through our work on climate change to increase awareness of risks and so support the transition to net zero. And I think under all of those things, we've sought to deliver financial stability but also at the same time support growth.
Go ahead then, and then jump off.
Thank you. Ben from The Times. There are some quite big estimates now for the compensation that might have to be paid out because of the motor finance issue that could destabilize, particularly the motor finance market. Do you think that could be something that sort of verges on a financial stability issue? Moody's have estimated a 30 billion payout, and we've already seen signs that parts of the market have frozen up.
Yeah, Sam, did you want to? Thanks, Ben. Look, as you'd expect, we've been spending a lot of time on that issue. I think the best way to answer your question is actually to look at the desk-based stress test we published today. So what we did in that test, we did not attempt to make a point estimate on that particular issue. As you say, Ben, there are many issues out there, many estimates out there, including the ones that you mentioned. What we did instead was take a crude but I think prudent approach. So we've taken the average of the conduct hit we've had in the first two years of each of the last three stress tests, that's 5 billion pounds a year, and we've run that for every year of the test. So that's quite conservative because in those previous tests those costs were very front-loaded. That's a 25 billion pound hit through the course of the test, and what you'll see is that even while taking a hit of that size, while also experiencing a very severe macroeconomic downturn, the system still has plenty of headroom. And one point to bear in mind, of course, is that compared to the numbers you were quoting, those are for the motor finance system as a whole, and of course we've only got part of that in this test. So I think what I'd say is that we do not consider that issue to be a risk to financial stability, but misconduct has often been quite a significant headwind, and therefore our job is to make sure that we're capturing that appropriately in a kind of stress testing that we do. The DBST published today and the heavy bottom-up test is for the big banks, but for any bank in this country, we do stress testing, they do stress testing through their ICAAP, and they have to take account of a reasonable stressed view of what conduct hits could be.
John Paul, who's just right behind you that way.
Yeah, hi. John Paul from The Daily Mail. A couple of things, please. There seems to be an increase in this report in the risks of global fragmentation. Has that risk been increased by the election of a US president who advocates sharp increases in trade tariffs, and could the rise in such risks lead to the kind of sharp, severe shocks described in the SES? If I may, a second question: has the impact of the budget and measures in the budget on financial stability, particularly in the corporate sector, been looked at? There's many specialists warning of rising insolvencies to come over the coming months, particularly as a result of the National Insurance changes.
Yes, so start with the global point. Let me reiterate to start with what I've said a number of times. I said it at the monetary policy press conference we had not that long ago. I think it's very important in the case of the outcome of the US election that, you know, I think I used the phrase 'when all is said and done,' and we wait for the administration actually to come into office to decide what its policies are going to be. We've had the saying, if you like, or we're having the saying, but I think it's really important, of course, that we recognize it's the doing that matters. And so I think it's very important to let that process happen, and we'll see. Now, you raised two points. I'll make on your point about risks: first of all, obviously, however risks move on the basis of what is expected to happen or what might happen, and we are seeing increased risk of global fragmentation. But I would say this: that there are quite a lot of causes of that, and I don't think it's right to just pin it on one particular event. We are living in a world that is, I'm afraid, more uncertain on a number of fronts, a number of very difficult events going on around the world. And so, of course, you can see that in, for instance, the Systemic Risk Survey that we run, that geopolitical risks figure very strongly in that. And of course, therefore, we do have to watch those risks very carefully. It's why we use stress testing, both of the desk-based sort that Sam was talking about and the SES, and that is a part of factoring that in into the risk. So I can assure you that we are watching and will continue to watch these risks very carefully, and of course, our job is to ensure that the system is resilient to those risks. On the budget, I mean, it's very much the same answer. We are not, I would say, at the moment seeing signs of any increase in what I would call corporate distress. To make your point, I don't think we're seeing any signs of that, but as you would expect, we will watch very carefully to see how the effects of all of this pass through into both the corporate and the household sector. That's our job, and we will continue to do that.
Laura and then Dave, please.
Hi, thank you. Laura from Bloomberg News. Just on the SES and the policy work that you kind of hinted to that needed to take place, both domestically in the UK and also internationally, given the growth push and given where the politics is internationally, how confident are you about actually being able to advance policies around NBFI here and then actually implement them?
Well, I'm sure Sarah wants to come on this. I mean, you're right, Laura, that of course it does rely on a very large amount of international coordination because of the nature of the risks and the nature of the sector we're dealing with. I think one of the facts that we've always pointed to that illustrates this is that if you go back to the LDI issue, most of those funds were not UK domiciled, just to give an example. But of course, the markets we're dealing with here as well, in terms of the SES, are actually, obviously by their very nature, very interconnected internationally. So we have to have international coordination and we have to have international action. It's why all three of us spend a large amount of our time involved in the Global Financial Stability Board, because that's obviously necessary, and the FSB is hugely important in the work it does, and we will continue to do that. I think that the SES is very important in this. I mean, I'm afraid you may detect that we're rather proud of the SES because it is world-leading, and we're going to say that frankly because it is. It's a very novel approach. Now, I think it's also novel in terms of what it does. It's also novel, I think, in terms of the situation we find ourselves in today, because I think that we are seeing quite a push back on what I called rule-making. And I think going back to the first question that was asked, actually, it's our job, of course, to point out the risks and then to ensure that we're resilient to them. And I think one of the important elements there is to have very good tools of surveillance so that we can lay out the issues, we can model the issues, and the SES is very innovative in terms of using the firms themselves to actually, in a sense, build those risks and that modeling. And so I think being able to lay out using very good surveillance tools and say, 'Look, here's the issues, now what are we going to do?' is important.
If I might add three things that are specific insights that flow, I think, from the SES and that help us articulate where there is a case for action. We can look at how the resilience, for example, of money funds is above their minimum requirements under the regulatory system and use that as evidence as to why money funds, not all of which are domiciled here in the UK, may need to have higher requirements. We can use the results in respect of how, for example, leveraged players behave in the SES to illustrate how, in the context of the FSB's work on non-bank leverage, concentrated, correlated positions matter more. Not all leverage is bad, but some is, and how it is priced in normal times, if it's priced low, haircuts are low, as we show in the FSR, is more likely to increase in stress, which can amplify it. Again, the SES really evidences that and gives us a great set of data to take into those discussions. And then the final thing I'd say is that there are some things that we can do on our own. Some of the learnings relate to the gilt repo market. That's something that we can do in the UK to support the resilience of the markets that are core to our financial stability. So I think all these three things really illustrate Andrew's point that the SES gives us the evidence to support the action that is required.
Thank you. David Robinson, Market News. The SES refers to the risk of a jump to illiquidity in the sterling corporate bond market. Now, unlike other areas, you don't seem to have very concrete plans about how you deal with this other than talking and assessment. At the same time, we're hearing a lot about growth matters, the need for capital deepening, chronic underinvestment in the UK. Isn't there a risk that the message people take from this is just don't buy sterling corporate bonds, or if you do, demand a high premium, and you just add to the problems?
Why don't I take that one. Look, the value of the SES is that it has shown us how stress in one market can cascade into stress in another, and we're able to see that in peacetime and do something about it before we find ourselves in that context, in that environment. Second thing I'd say is, do remember how big a stress the SES is. It's faster, it's more wide-ranging, it's more persistent than anything we've seen in the past, and so one should expect there to be a market reaction to it. Nonetheless, your point about jump to illiquidity is well made. One of the things we're doing is working with the pensions regulator so that they can work with their pension fund regulatees in order to work out how they are thinking about these issues. And there is some work for us to do to understand how long would such stress last for. If it's two days, that's very different than if it's two months. So there is more work for us to do. The great thing is that the SES has highlighted that in advance, and to Laura's point from before, we will be taking this into the international debates too.
I think I'd just add one rather simple point, which is I think we should also, it's also important to have a sense of proportion here. I mean, I would wager there are probably more long-term investors in the corporate bond market than there are in some other markets, which is why, for instance, something like the basis trade isn't done in the corporate bond market. So, you know, in some ways we are revealing some of the basic facts of these markets. But as Sarah says, the point about the SES is it just lays it out and says, you know, here's the dynamics, if you like, of these markets. I might add one other thing: in all of financial stability analysis, you build resilience in advance, but you don't build resilience to every possible state of the world because to do so would be expensive and disproportionate. So some of the learnings can sometimes be for how do you deal with those events.
Martin Arnold, Financial Times. I have two questions, if I may. The first is, the 10-year borrowing costs of France recently rose above those of Greece, and there are significant concerns about some of the high levels of sovereign debt and high budget deficits out there. Has the Bank of England taken any action to examine the risks that could potentially stem from a rise in bond vigilantism, if I can call it that? And the second is, as a result of the SES, are you more or less concerned about the risks to the financial system from outside the banks?
Thank you. I'll start the first one, you may want to come on the second one. Well, obviously, Martin, we obviously watch the movement in government bond rates. As you say, one thing I would say is, and we've drawn this point out in quite a lot of financial stability reports over recent years, is that obviously we do see, if anything, a shift in bond markets towards higher levels of borrowing on the sovereign side. As we point out in this Financial Stability Report, and you look at the UK, actually, UK households and corporates are actually not showing the same signs in that respect. So there is naturally, that follows, there is more focus on sovereign debt markets, and of course, as the SES shows, they are actually very important in terms of broader transmission of financial stability. So for that reason, we do watch it very carefully. Now, we can obviously attest from our own experiences of a couple of years ago that sovereign bond markets can move around very quickly, and you do have to be ready to deal with the consequences of that. What I would just say again is that's why I think having the tools of surveillance and then, as Sarah was saying, having the tools to respond is so important in this world, and particularly where we're talking about market risk in this sense. And as Sarah rightly said, some of those tools are what I would call standing regulation, but some of the tools are actually central bank intervention tools, because the cost of actually having standing regulation much further out into the tail of the distribution of bad outcomes is very high and gets disproportionate. You know, this is another aspect of this growth versus financial stability debate. It is more efficient to have central bank tools to come in and deal with those events. One final point I would make on that, though, is that, and this is what we're doing, and you'll have seen we're going to introduce our own repo facility, for instance, in this area, that I think it's important that while we are not providing standing facilities to the non-bank world, that's a big distinction between banks and non-banks, formalizing so that people understand what's going to happen from our side if and when we do have to intervene in those sorts of stress situations, and therefore laying them out on a more formal basis rather than us going off into a huddle in the middle of the night and coming up with something as we have done, I think is a very good thing because it increases the transparency of the market's understanding of where we will be.
And on your question about are we more or less worried, we've been talking about the resilience and the importance of market-based finance for a long time. What the SES has done is give us really clear sight of where there is more work to do. So there was some good news on the resilience of the gilt market, that the actions that we'd taken, that market participants had taken, meant that that market was resilient to the stress. But we also saw how individually rational actions in the gilt repo market could lead to collective stress that meant that the market was less resilient than it could be. And so there's some work there for us to do. So am I more or less worried? I always was worried. I think this gives us a real agenda for our next steps, and that gives us confidence that at least we know what to do. I'm only worried when Sarah's not worried.
Tim Wallace at The Daily Telegraph. Two questions as well, please, if I may. Firstly, given your worries on sovereign debt, how concerned are you about the UK's debt trajectory that the OBR spelled out last month? There's quite a big increase coming up. Is that sustainable? Are there risks to that given the global hazards you've listed in the FSR? And secondly, on cyber attacks, what sort of cyber attacks do you have in mind? Are banks under more attack from, sorry, on cyber attacks, what do you have in mind there? Is it hostile states attacking banks at the minute, or is it terrorist groups or fraudsters? Which sort of threats should we be concerned over?
Well, Tim, thanks. Tim, start on the OBR. The OBR set out, as you said, actually a long-run trajectory, and that's a very good thing that they do. I think the thing that I take from that is that it's a very timely and important reminder. And of course, this is not, by the way, I mean, the UK is not unique in this at all, by the way. I mean, it's not unusual that we have some very big headwinds running against us, I would say, almost globally. And the three that I would pick out are aging population, obviously, the UK is not at all unusual in this respect. I mean, it's common amongst almost all industrialized countries, and obviously the consequences of an aging population. The second one I would pick out is the fact that the post-Cold War sort of, in a sense, dividend in terms of defense spending seems unfortunately and very sadly to have come to an end. The third one is climate change. Now, be a bit careful on what I say here because I don't want for a moment to suggest that it is the responsibility of the state to tackle the consequences of climate change on its own, but states do, I think, have a role there to play. You can take all sorts of views on climate change. Unfortunately, we as a regulator, particularly of insurance companies, for instance, do see some signs that I'm afraid there is evidence of it. But the point is, I think all of those three things are very big structural challenges that are affecting many countries, UK included, and it's right for the OBR to point to these sort of trajectory issues over the long term because they really illustrate and bring into sharp relief the challenges that we are dealing with. It's not about politics in any direct sense, it's about structural challenges that we're facing. On cyber, I mean, cyber is, you're very right to point to it. I mean, first of all, I'd say cyber is, you know, if you ask me which risk has come fastest up the league table since the global financial crisis in the last 15 years, it's cyber. It has come very fast up the league table. That's the first thing I'd say. The second thing is it never goes away, and that's a difference. A lot of what we're doing is mitigating risks in the sense of trying to create a situation where over the long run we can be much more comfortable about the risk. Unfortunately, with cyber, we obviously have to mitigate it. By the way, don't for a moment get me wrong on that, but I'm afraid the other thing we have to recognize is that it is constantly evolving as we speak.
I think maybe just to add briefly, I think it's reasonable for us to be even more concerned about that in a period of rising geopolitical tensions, and the boundary between state and non-state threat actors in this area is not entirely clear. So we are very much on that, with developing further the penetration testing regime that we've had in place for many years, but as Andrew was saying, that has to keep evolving to keep pace with the changing nature of the threat. We've also had a very significant uplift of operational resilience across the financial sector. We've got a key deadline actually in Q1 of next year. Now, that's not just cyber, but I think it's worth making that point because of course the most dramatic impact we've had, at least this year, I would say fortunately not so much in financial services, was not in fact from a cyber attack, it was from the CrowdStrike incident, and that illustrates that need for wider operational resilience. So that's also an area where we continue to develop.
Thank you. Lawrence with Reuters. Just building on the earlier discussion about the system-wide exercise and the kind of actions arising from it, can you elaborate on the findings of the SES on the mismatch in expectations between non-banks' need for funding from banks in the crisis and the banks' willingness to provide it? What explains that mismatch? Is it just that they wanted more from banks than banks were willing to provide? And what can you do about it, because it seems quite key to the findings of the SES?
Very great question. So look, there's two aspects of demand for funding: one is quantity and one is the haircuts that are applied. The learnings from the SES showed us three things. Firstly, banks were prepared to roll existing levels of funding. Two, where expectations were of more funding, not all of those would be accommodated. And third, that the haircuts applied to that funding would increase. And there's a great chart in the FSR that shows for much of gilt repo, the modal haircut, the most common haircut, is zero. So it can only go one way in a stress. So what the SES does is highlight those issues, enables us to show to the world that if you're expecting more funding to come through in a stress, it might not happen, and the provision of that will be at tighter terms. So you need to react to that now. Your question was, should we be encouraging that provision of funding? These are driven by counterparty credit risk concerns, they're commercial decisions, it's not a reaction to any prudential requirement. So I don't think it would be wise for us to be encouraging it. But what we can do is put the terms on which it is provided in normal conditions on a more resilient basis, to think about minimum haircuts, for example, and we could also think about whether central clearing would be a sensible addition to do so. I think it's shone a light on this mismatch of expectations, highlighted how important that might be for financial stability, and there's stuff for us to do. But encouraging banks to provide the repo at terms that they're not commercially comfortable with doesn't strike me as the right response.
