BoE launches "first of its kind" system-wide exploratory scenario (SWES) exercise - with a focus on market-based finance

On 19th June 2023, the BoE launched its first system-wide exploratory scenario (SWES) exercise. The aim of the SWES is to improve the BoE’s understanding of the behaviours of banks and non-bank financial institutions (NBFIs) during stressed financial market conditions, and how those behaviours might interact to exacerbate shocks in UK financial markets that are core to UK financial stability.

In recent years, events in a number of global markets have illustrated how liquidity conditions can quickly deteriorate – underlining some of the vulnerabilities in market-based finance. In light of these events. The BoE has requested that a group of banks and NBFIs who are active in UK financial markets participate in a collaborative SWES exercise to:

• enhance understanding of the risks to and from NBFIs, and the behaviour of NBFIs and banks in stress, including what drives those behaviours; and
• investigate how these behaviours and market dynamics can amplify shocks in markets and potentially pose risks to UK financial stability.

The BoE is also interested in the role that firms might play in stabilising markets in the event of a shock.

Notably, the SWES is not a test of the resilience of the individual firms that have been asked to participate. Its focus is system-wide, including on important UK financial markets and their resilience in times of stress.

The initial stage will involve collaborative information gathering to help in designing an effective stress scenario. Later in 2023, firms will be asked to evaluate the impact of a severe but plausible stress to global financial markets. This latter stage will take place over 2 phases with banks, insurers and fund managers first asked to model the impact of the shock, and their intended actions in response to it. The BoE will then identify how that scenario may be affected by the firms’ collective actions. Firms will then be asked how an updated scenario (which takes into account any potential amplification effects) might lead them to take different actions. CCPs will also contribute by providing data on CCP’s margin calls implied by the scenario.

Although the SWES will seek to build a picture of how firms in general respond to stress, its key focus is on specific markets – being the gilt market, gilt repo market, sterling corporate bond market and associated derivative markets (e.g., gilt and SONIA futures; and interest rate, cross-currency and inflation swaps), and the BoE’s detailed analysis will centre on the resulting impact on these ‘markets of focus’.

What comes next?

The BoE expects to publish its final report in 2024. The BoE has previously indicated the need “to develop and adopt policy reforms to increase resilience across the system of MBF”, advocating for international and domestic regulators to implement appropriate policy responses in 2023 to address the risks from MBF to financial stability.  This SWES will inform the BoE’s domestic approach – and any resultant domestic policy reforms.

Related materials

You can find the BoE new web page for the SWES here.

The BoE's Financial Policy Committee (FPC) first announced the new SWES exercise in December 2022 - see here