Analysts worry about spillover effects on the UK’s shadow banking sector if interest rates spike.
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LONDON — After last week’s turmoil in the UK bond market following the government’s September 23 ‘mini-budget’, analysts are sounding alarm bells for the country’s shadow banking sector.
The Bank of England was forced to intervene in the long-running bond market after a plunge in British government bonds, known as ‘The Gilt’, threatened the country’s financial stability.
The panic was particularly focused on pension funds holding sizable amounts of gold coins, but a sharp rise in interest rate expectations also caused turmoil in the mortgage market.
While central bank intervention has brought precarious stability to the British pound and bond markets, analysts have warned against the country’s shadow banking sector, financial institutions that act as lenders or intermediaries outside of the traditional banking sector. It warns of protracted stability risks.
Former UK Prime Minister Gordon Brown, who introduced bailouts to UK banks during the 2008 financial crisis, told BBC radio on Wednesday that UK regulators need to step up supervision of shadow banks. rice field.
“I worry that many companies and organizations will face serious problems when inflation sets in and interest rates rise. Pension funds were the last to be bailed out, so I don’t think this crisis is over. week,” Brown said.
“I think there is a need for perpetual vigilance about what happened to what is called the shadow banking sector, and I fear that further crises are coming.”
Global markets rebounded from weakening economic data in recent sessions. This is seen as reducing the likelihood that central banks will be forced to tighten monetary policy more aggressively to keep very high inflation in check.
Edmund Harris, chief investment officer at Guinness Global Investors, told CNBC on Wednesday that while inflation will be moderated by lower demand and the impact of higher interest rates on household incomes and purchasing power, the danger is that “the It is the shattering and extension of the decline.”
The U.S. Federal Reserve has repeatedly pledged to keep raising interest rates until inflation is under control, and Harris said inflation above 0.2% month-on-month was viewed negatively by the central bank and would encourage more aggressive growth. suggested that it would facilitate a tightening of monetary policy. .
Sudden and unexpected changes in interest rates that have accumulated leverage in the “dark corners of the market” during the last ultra-low interest rate period could expose areas of “fundamental instability,” Harris said. suggested.
“Going back to the issue of pension funds in the UK, pension funds needed to meet their long-term debt and ensure cash flow through gold coin holdings, but ultra-low interest rates meant they weren’t. To get, they applied swaps up — that’s the leverage to get those returns,” he said.
“For non-bank financial institutions, the problem is likely to be access to financing. Belts must be tightened, credit terms must be tightened, and those most in need of short-term finance will starve as we begin to move toward capital preservation.”
Harris suggested the UK is not there yet, as there is still plenty of liquidity in the system for now.
“Money will be more expensive, but it’s the availability of money that finds some kind of crisis,” he added.
The more debt held by non-bank institutions such as hedge funds, insurance companies and pension funds, the higher the risk of spillovers through the financial system. Capital requirements for shadow banks are often set by counterparties rather than regulators as in traditional banks.
This means that when interest rates are low and there is abundant liquidity in the system, these collateral requirements are often set very low.
Last week, some pension funds were triggered by the Bank of England’s action and some began receiving margin calls as the value of gold coins plummeted. A margin call is a request to the broker to increase the equity in the account if the value of the account falls below the broker’s requested amount.
Sean Corrigan, director of Cantillon Consulting, told CNBC on Friday that pension funds themselves are in a fairly strong capital position due to rising interest rates.
“They’re actually outperforming actuarial funding for the first time in five or six years. They’ve clearly had margin issues, but who has thin margins?” he said. .
“It’s the other party who passed it on and shuffled around themselves. If there’s a problem, they probably didn’t see the right part of the building in danger of collapsing.”