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IMF Country Report No. 22/57

UNITED KINGDOM

FINANCIAL SECTOR ASSESSMENT PROGRAM FINANCIAL SYSTEM STABILITY ASSESSMENT

February 2022

This paper on United Kingdom was prepared by a staff team of the International Monetary Fund as background documentation for the periodic consultation with the member country. It is based on the information available at the time the FSAP Assessment was completed in November 2021. This paper was discussed by the IMF Executive Board on February 16, 2021.

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Press Release

UNITED KINGDOM

FINANCIAL SYSTEM STABILITY ASSESSMENT

February 2, 2022

KEY ISSUES

Context: The U.K. financial sector is globally systemic, open, and complex. It has weathered the COVID-19 pandemic fittingly, thanks to the post-GFC reforms, a proactive macroprudential stance, and an effective multipronged response to maintain financial stability. Brexit uncertainties are being handled appropriately as the U.K. and EU authorities and the financial industry collaborate to prevent undesirable financial stability outcomes. The endpoint of the pandemic remains unclear, as does the actual impact on the financial system once support measures wane. At this juncture, therefore, financial stability conditions in the United Kingdom are being shaped by three key considerations: (i) the evolving U.K.-EU relationship on financial services; (ii) securing a sustainable and robust post-pandemic economic recovery; and (iii) successfully managing ongoing structural transitions.

Findings: The U.K. financial system is benefiting from a robust financial stability framework. The FSAP team has assessed capital and liquidity levels at core banks and insurers as strong—even under some severely adverse scenarios, including the re-emergence of the pandemic, and a tighter monetary policy stance. The financial stability institutional framework rests upon effective interagency collaboration. The globally critical market infrastructures remain in good form, and the authorities have shown leadership in the global LIBOR transition. With these positives, the FSAP recognizes five areas that could bear upon financial stability as the pandemic subsides and global financial conditions change: (i) the strength of banks and insurers could give way to potential risks posed by their counterparties; (ii) a buoyant housing market may encourage overborrowing; (iii) financial interconnectedness may add new channels of market interactions and contagion; (iv) surfacing of liquidity mismatches in the internationally active NBFIs; and (v) the post-Brexit operating models of international banks and financial firms. Collectively or singularly, these pose a challenge for the financial stability authorities.

Policies: Fully recognizing the strengths, the FSAP has proposed four directions going forward: (i) bolstering management of systemic risks; (ii) continued strengthening of regulation and supervision; (iii) minimizing risks of transitions and future crises; and (iv) securing institutional safeguards for financial stability and market integrity. A few of the FSAP recommendations necessitate active cooperation from cross-border central banks, financial stability authorities, and regulators.

• The FSAP team was led by Udaibir Das (Mission Chief). It comprised of Juan Solé (Deputy Mission Chief), Atilla Arda, Kelly Eckhold, Tamas Gaidosch, Pierpaolo Grippa, Vikram Haksar, Jan Moeller, Paola Morales, Jin Podpiera, Luc Riedweg, and Peter Windsor (all MCM); Ruo Chen (EUR); Jonathan Pampolina (LEG); and Sigridur Benediktsdottir, Timo Broszeit, Thomas Curry, Greg Feldberg, and Stathis Tompaidis (experts). The FSAP team received valuable supplemental inputs from Hans Weenink and Ender Emre (both LEG). In addition, Marika Santoro (RES) and Federico Grinberg, Romain Bouis, Priscilla Toffano, Hou Wang, Matyas Zoltan, Ken Zhi Gan, and Pavel Lukyantsau (all MCM) provided targeted analytical help. Dan Cheng and Lamia Khandker provided research and administrative support, respectively.

• The mission met with Chancellor Sunak, Governor Bailey, and CEO Rathi, as well as their respective staffs at Her Majesty’s Treasury (HMT), the Bank of England (BOE), the Prudential Regulation Authority (PRA), and the Financial Conduct Authority (FCA). It also met staff at the Competition and Markets Authority (CMA), the Financial Services Compensation Scheme (FSCS), and The Pensions Regulator (TPR), and representatives of the U.K. financial industry.

• FSAPs assess the stability of the financial system as a whole and not that of individual institutions. They are intended to help countries identify key sources of systemic risk in the financial sector and implement policies to enhance its resilience to shocks and contagion. Certain categories of risk affecting financial institutions, such as operational or legal risk, or risk related to fraud, are not covered in FSAPs.

• The United Kingdom is deemed by the IMF to have a systemically important financial sector according to SM/10/235 (9/16/2010), and the stability assessment under this FSAP is part of bilateral surveillance under Article IV of the IMF’s Articles of Agreement

Approved By

May Khamis and Laura Papi

Prepared By

Monetary and Capital Markets Department

Contents

• Glossary

• EXECUTIVE SUMMARY

• FINANCIAL STABILITY CONTEXT

• A. Pandemic Shock and Macrofinancial Conditions

• B. United Kingdom in Global Finance

• ISSUES IN SYSTEMIC RISK AND RESILIENCE

• A. Brexit and Financial Stability

• B. Macrofinancial Linkages

• C. Banking Sector Solvency and Liquidity

• D. Insurance Sector Solvency and Liquidity

• E. Market-Based Finance

• F. Central Counterparties

• G. Asset Managers

• H. Systemic Liquidity and Core Markets

• I. Real Estate Markets

• J. Climate-Related Vulnerabilities

• ISSUES IN SYSTEMIC RISK MITIGATION, OVERSIGHT, AND SUPERVISION

• A. Macroprudential Framework

• B. Microprudential Framework

• CROSSCUTTING CHALLENGES TO FINANCIAL STABILITY

• A. LIBOR Transition

• B. Open Banking and Crypto Assets

• C. Cybersecurity Threats

• D. Combating Financial Crimes and Safeguarding Financial Integrity

• PREPARING FOR FUTURE CRISES

• A. Resolution Framework

• B. Internationally Active Mixed Financial Groups

• C. Agency Independence and Resources

• AUTHORITIES’ VIEWS

• BOXES

• 1. Structural Features of the Financial System

• 2. Select Financial Stability Data Gaps

• FIGURES

• 1. Macrofinancial Indicators

• 2. Macrofinancial Linkages

• 3. United Kingdom and the Core Global Financial System

• 4. Systemic Stress Scenarios

• 5. Nonfinancial Corporates

• 6. Nonfinancial Corporates Under Stress Scenarios

• 7. Households Balance Sheets

• 8. Bank Stress-Tests At-A-Glance: Scenarios and Results

• 9. Bank Solvency Stress Test Results

• 10. Solvency Stress Test Results

• 11. Macrofinancial Feedback Effects

• 12. Insurance Sector—Solvency and Profitability

• 13. Insurance Solvency Stress Test

• 14. Insurance Liquidity Risk Analysis

• 15. Credit Cycles

• 16. IM and VM Margin Calls

• 17. Money Market Funds

• 18. Fixed Income and Equity Open-End Funds

• 19. Alternative Investment Funds

• 20. Systemic Liquidity Stresses and the BOE’s Response

• 21. Housing Price Developments and Household Debt Indicators

• 22. Methodological Approaches for Climate Risk Analysis

• 23. The Logic of the ‘Climate Minsky Moment’

• 24. Insurance Climate Risk Analysis

• 25. Indicators of the Importance of LIBOR and Transition Progress

• 26. Supervisory Population of Entities with AML/CFT Obligations

• 27. AMF/CFT: Comparison of Mutual Evaluation Report Ratings

• TABLES

• 1. Key Recommendations

• 2. Selected Economic Indicators, 2018–25

• 3. Financial Soundness Indicators, 2015–2020

• 4 Core Global Financial Network, and Degree of Interconnectedness, 2020

• 5. High-Priority Exit Risks and Other Selected Exit Risks

• 6. Proportional Liquidation Asset Profile for MMFs Under a Weekly Redemption Shock

• 7. Proportional Liquidation Maturity Profile for MMFs Under a Weekly Redemption Shock

• 8. FPC’s Annual Assessment of Risks Banking and Selected Inputs

• APPENDICES

• I. Banking Sector Stress Test Matrix

• II. Insurance Stress Testing Matrix

• III. FSAP Risk Assessment Matrix

• IV. Implementation Status of 2016 Key Recommendations

Glossary