Britain’s shadow banking system is raising serious concerns after the bond market storm | Techy Kings


Analysts worry about the impact on the UK’s shadow banking sector in the event of a sharp rise in interest rates.

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LONDON — After last week’s chaos in Britain’s bond market following the government’s Sept. 23 “mini-budget,” analysts are sounding the alarm about the country’s shadow banking sector.

The Bank of England was forced to intervene in the long-dated bond market after a massive sell-off of UK government bonds – known as “gilts” – threatened the country’s financial stability.

Panic focused particularly on pension funds, which hold large amounts of gold, while a sharp rise in interest rate expectations also caused turmoil in the mortgage market.

Although central bank intervention offers some fragile stability to British pounds and bond markets, analysts have flagged lingering stability risks in the nation’s shadow banking sector — financial institutions acting as lenders or intermediaries outside the traditional banking sector.

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Former British Prime Minister Gordon Brown, whose administration introduced a rescue package for British banks during the 2008 financial crisis, told BBC Radio Wednesday that UK regulators need to tighten their oversight of shadow banks.

“I’m worried that when inflation hits and interest rates go up, there will be some companies, some organizations that will have severe difficulties, so I don’t think this crisis is over because the pension fund was bailed out last week,” Brown said.

“I think there needs to be eternal vigilance about what has happened to the so-called shadow banking sector, and I fear there will be more crises to come.”

Global markets took heart in recent sessions from weak economic data, which appeared to reduce the likelihood that central banks will be forced to tighten monetary policy more aggressively to curb skyrocketing inflation.

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Edmund Harriss, chief investment officer at Guinness Global Investors, told CNBC today that while inflation will be affected by the decline in demand and the impact of higher interest rates on household incomes and spending power, the danger is “the grinding and extension of weaker demand.” .”

The US Federal Reserve has reiterated that it will continue to raise interest rates until inflation is under control, and Harriss suggested that a month-on-month inflation print of more than 0.2% would be viewed negatively by the central bank, prompting more aggressive monetary policy tightening.

Harriss suggests that sudden and unexpected changes in rates where leverage has built up in “dark corners of the market” during previous periods of ultra-low rates could reveal areas of “fundamental instability.”

“Going back to the pension fund issue in the UK, it’s the pension fund’s need to meet long-term liabilities through their gold holdings, to get cash flow, but ultra-low rates mean they don’t get returns, so they use swaps above — that’s leverage to get that return,” he said.

“Financial institutions are not banks, the issue that may arise is access to financing. If your business is built on short-term financing and one step back, lending institutions need to tighten their belts, tighten credit conditions and so on, and start moving towards preservation capital, then the people who will starve are those who need short-term financing the most.”

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Harriss suggests that the UK is not there yet, however, as there is still sufficient liquidity in the system for now.

“Money is going to be more expensive, but it’s the availability of money when you find some sort of crisis point,” he added.

The greater the debt held by non-banking institutions, such as hedge funds, insurers and pension funds, the higher the risk of ripple effects through the financial system. Shadow banks’ capital requirements are often set by the counterparties they deal with, rather than regulators, as is the case with traditional banks.

This means that when rates are low and there is a lot of liquidity in the system, these collateral requirements are often set quite low, meaning that non-banks have to suddenly post huge collateral when the market goes south.

Pension funds sparked Bank of England action last week, with some starting to receive margin calls due to the fall in the value of gilt. A margin call is a request from the broker to increase the equity in the account when its value falls below the amount required by the broker.

Sean Corrigan, director of Cantillon Consulting, told CNBC Friday that pension funds themselves are in a relatively strong capital position due to higher interest rates.

“They’re actually now ahead of funding on an actuarial basis for the first time in I think five or six years. They obviously have a margin problem, but who’s the narrow margin?” he said.

“It is the business partners who have channeled it and revamped it around them. If there is an issue, maybe we don’t see the right side of the building that is at risk of falling.”


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