(Reuters) - The Bank of England said it has begun simulating stress scenarios in “stretched” bond markets to see if they risk undermining financial stability, though no proven problem has been uncovered so far.
Alex Brazier, the BoE’s executive director for financial stability strategy and risk, said market-based finance is a “next frontier” for its policymaking as companies issue far more bonds to raise funds than they did before the financial crisis.
“With credit markets and commercial property markets stretched, a broadening of our work is timely,” Brazier said in a speech on Thursday.
There were questions about resilience and liquidity in bond markets, even if the firms who operate on them are safe, Brazier said.
A focus is so-called “liquidity mismatch” or difficulty in finding buyers or sellers of bonds in stressed markets.
Banks say bond markets are less liquid because tougher regulation introduced after the financial crisis makes holding inventory for buying and selling at all times too expensive.
“The issue is not whether or not to row back on those regulatory standards, it’s to make sure the system adapts fully to corporate bond markets being generally less liquid and able to absorb asset sales,” Brazier said.
There has been growth in the share of corporate bonds held in funds that offer redemptions at just a day’s notice, a challenge if there are few buyers of bonds to raise the cash.
A mismatch of liquidity could worsen price adjustments in markets.
“That’s why we’ve been developing simulations of the impact of this liquidity mismatch,” Brazier said.
The BoE is also looking at how investors rely on “volatility” benchmarks to bet on bond markets remaining stable.
“In both cases, there is no proven problem for markets or the economy. Inquiries, are, as the police like to say, ongoing,” Brazier said.
BoE Governor Mark Carney said last week that markets are likely to be affected when central banks around the world raise interest rates, but reforms since the financial crisis mean that would have a limited impact on the real economy.
Reporting by Huw Jones; Editing by Andrew Heavens and Hugh Lawson