Bank of England doubles liquidity requirements for Money Market Funds

The Bank of England is pushing for money market funds to be able to hold twice as much easily-sellable assets. This is the latest step taken by financial watchdogs around the world to reduce Shadow Banking risk.

Experts on financial stability at the BoE recommended tighter liquidity requirements in sterling money market funds, citing risks such as geopolitical tensions or “stretched valuations” in certain markets.

The BoE said in its quarterly financial stability report on Tuesday that “the overall risk environment continues to be challenging”. The BoE also noted the increasing household debt and the tripled prevalence of mortgages with a term longer than 35 years in the UK.

Shadow banks are a wide range of financial institutions, from hedge funds and insurers to nonbank lenders. They have been at a number of recent crises including the rush for cash when the pandemic struck in March 2020, the UK gilts crisis late in 2022, as well as the panicked markets in March 2020.

The announcement on Tuesday was just the latest of a series of steps aimed at reducing the risk in different areas of the shadow bank sector.

The UK has already implemented higher liquid standards for liability-driven investments vehicles used by pension funds. Leveraged vehicles contributed to the 2022 gilts crises through a massive sell-off in bonds following Liz Truss’s “mini” Budget.

According to the recommendations, money-market funds would be required to keep 50-60% of their assets in liquidable assets within a seven-day period.

The industry average is 45-50 per cent. Money market funds denominated in sterling have £250bn worth of assets. However, most of these are held within the EU.

The BoE stressed that international coordination is important to reduce the risk of the fund industry.

The Financial Conduct Authority (which supervises money-market funds) and Treasury will consult about the UK’s requirements in the latter part of this year. The US has already declared that a 50% weekly liquidity requirement is required.

Experts in financial stability at the BoE have also announced a revamp of next year’s stress test for banks to better capture risks associated with a prolonged period of high interest rates following more than a decade loose monetary policies.

After the financial crisis, the bank’s stress testswere introduced as an annual test to ensure that lenders were prepared for any potential crises.

The central bank has announced that in 2024 it will conduct an internal exercise to test against a variety of shocks. The results will be released for the entire system.

BoE asks eight banks to conduct their own stress test against a specific scenario, and then publishes the results of each bank individually. It intends to return to this structure by 2025.

In a separate statement, the Federal Reserve noted on Tuesday that hedge funds continue to hold “materially leveraged positions” in US Treasuries and stated it will “continue monitoring risks to core markets function and financial stability caused by leveraged trades made in government bond market”.

In its assessment of UK’s outlook the BoE stated that households are “under pressure” by higher living costs. It also noted an increase in the number of households who have a heavy debt burden. However, this level is still lower than the 2007 peak.

The assessment found that households have reacted to rising rates by extending mortgages. 12 percent of mortgages now last 35 years or longer, compared with 4 percent in the first quarter 2021.

The BoE stated that this trend could reduce debt payments in the short term, but “increase it over time”.