Financial market weaknesses ‘responsible’ for pandemic dysfunction, says BoE

Financial market vulnerabilities led to tightening of financial conditions and dysfunction in March 2020, according to Jonathan Hall, member of the Bank of England’s (BoE) financial policy committee.

Hall said that weaknesses had been exposed during the period and were responsible for disruption even in the most liquid markets, like US treasuries and UK gilts.

“Actions by market participants that may have been rational when considered in isolation, led to systemic issues when considered in aggregate,” the committee member said in a speech at the business school at Cardiff University, Prifysgol Caerdydd. “Although it was health concerns that understandably dominated front page news at the time, we should not underestimate the severity of the financial stress.”

Hall claimed that without “extraordinary” and fast actions by central banks, including the BoE, these vulnerabilities would have worsened outcomes for households and businesses.

According to him, although financial markets have recovered over the past year, there have been several isolated incidents that suggest that these weaknesses still exist.

He said that if these flaws were to remain without policy action to increase resilience, the bank would expect to see similar dynamics in the future.

Hall outlined six key proposals to help build resiliency in the market:

1. Increase transparency and reduce pro-cyclicality in margin calculations. Ensure all derivatives users enhance planning for, and management of, liquidity outflows.
2. Reform money market funds so that they are either regulated and managed in a way that allows them to perform their function in times of stress, or are no longer considered cash-like investments
3. Ensure that open-ended investment funds align their redemption terms with the liquidity of their assets. They can do this by holding more liquid assets, by lengthening redemption periods, or through more effective use of swing pricing.
4. Make it a principle to always analyse market structure changes in the context of their impacts on liquidity in bad times as well as good.
5. Consider actions to reduce both jump-to-illiquidity risk, and the risk that excessive leverage by non-bank financial institutions causes market dysfunction in stress.
6. Examine central bank tools, including exploring offering central bank government bond repo, with very high haircuts, to a broad array of counterparties that meet appropriate standards.

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