On 29 November 2024, the Bank of England (BoE) published its final report on the system-wide exploratory scenario exercise (SWES), which explores how the UK financial system would respond to a market shock.

The SWES exercise

As a system-wide exercise, incorporating a wide range of financial firms and business models, the SWES is intended to provide insights into the behaviour of different parts of the financial system under stress, as well as the dynamics driven by their interactions and how these can affect outcomes in markets core to UK financial stability and the financial system as a whole. Its aims are to:

  • Enhance understanding of the risks to and from non-bank financial institutions (NBFIs), and the behaviour of NBFIs and banks in stress, including what drives those behaviours.
  • Investigate how these behaviours and market dynamics can amplify shocks in markets and potentially pose risks to UK financial stability.

The BoE explains that the SWES is the first exercise of its kind globally; unlike traditional firm-focused stress tests, it takes a system-wide perspective and incorporates complex firm behaviours and interactions through the active engagement of around 50 different financial firms.

Conclusions

The report sets out 6 key financial stability conclusions from the SWES:

  • Firms’ collective actions amplify the initial shock. While non-bank resilience has increased in a number of sectors and firms over recent years, some of that resilience could deteriorate or change over time, risking greater amplification by the financial sector in the future.
  • Repo market resilience is central to supporting core markets in stress. During a market stress, banks are unlikely to provide all of the additional repo financing NBFIs ask for, despite their willingness to draw on central bank lending facilities.
  • The SWES illustrates how actions taken by authorities and market participants following recent market shocks have improved gilt market resilience; however, further work is required given the other vulnerabilities highlighted by this exercise.
  • The sterling corporate bond market could face a ‘jump to illiquidity’ in stress, whereby the speed of selling pressures significantly exceeds purchasing capacity and prices need to fall rapidly for the market to clear.
  • System-wide stress exercises have proved to be an effective tool for financial stability authorities to understand system-level vulnerabilities. The BoE, alongside the Financial Conduct Authority, will continue to invest in its capabilities in this area for surveillance and risk assessment, and to run future exercises.
  • System-wide exercises are important for regulators, firms and markets.