Securing Funding in Critical Areas
In a lecture delivered at OMFIF, Nat Benjamin, the executive director of financial stability strategy and risk at the Bank of England, emphasized the need for a balanced approach to fostering a steady-state liquidity environment that supports stability and growth.
According to Benjamin, this approach requires a careful consideration of the normalization of central bank balance sheets and the evolving roles within the financial system, particularly the shift from banks to non-bank financial institutions (NBFIs). This balanced strategy ensures effective liquidity flows system-wide and preserves households’ and businesses’ access to essential financial services.
One key consideration is the normalization of central bank balance sheets. Benjamin highlighted the importance of carefully calibrating monetary and regulatory frameworks during the normalization phase so that liquidity is abundant and cheap enough to maintain market depth under normal conditions, but not so inexpensive as to encourage excessive leverage that could destabilize the system in stress periods.
Another critical aspect is the evolving roles within the financial system. With greater roles for NBFIs alongside traditional banks, Benjamin stressed that both banks and NBFIs must manage their liquidity risks prudently, learning from past market stresses like the 2022 Liability Driven Investment episode. Banks remain critical providers of liquidity to NBFIs, and their liquidity management practices—including access to central bank liquidity facilities—impact the system's overall liquidity distribution.
The implications of these changes for system-wide liquidity flows are significant. Ensuring a steady-state liquidity environment requires maintaining incentives for institutions to hold liquidity buffers and to lend prudently within the financial markets, supporting households and businesses in accessing credit, deposits, and payments infrastructure reliably.
Decisions on the monetary operating framework and regulation need to strike a “middle road” that encourages institutions to maintain liquidity insurance individually while supporting system-wide liquidity through market lending. This dual incentive approach promotes resilience in funding markets both in normal times and under stress, reinforcing overall financial system stability and sustainable economic growth.
Furthermore, Benjamin underscored the importance of international cooperation in navigating these financial system shifts. Maintaining a steady-state liquidity environment requires a global perspective, as changes in one region can have ripple effects on others.
In conclusion, Benjamin argued for a comprehensive and balanced strategy addressing the interplay between central bank policies and the shifting financial landscape, aiming for a liquidity environment that is stable, growth-supportive, and inclusive of all economic agents’ needs. By adopting this holistic approach, we can better manage the risks associated with these changes and ensure the stability and growth of our financial systems.
Using AI and data analytics, the Bank of England's executive director of financial stability strategy and risk, Nat Benjamin, proposes that they should develop a risk-assessment model for non-bank financial institutions (NBFIs) to evaluate their liquidity risk management practices, ensuring a stable financial system during periods of stress like the 2022 Liability Driven Investment episode. Additionally, this model should be integrated into the finance business, providing insights on the monetary and regulatory frameworks for both NBFIs and traditional banks, thus enhancing the overall liquidity distribution and promoting sustainable economic growth.
