Bank of England warns of risks from trade war

A looming trade war, rising geopolitical instability and mounting government debt burdens have pushed up the risks facing the financial system, the Bank of England has warned.
The UK is particularly exposed to rising threats because the country has an “open economy with a large financial sector”, officials on the Bank’s financial policy committee cautioned on Thursday.
“We are living in a world, I’m afraid, that is more uncertain on a number of fronts,” Andrew Bailey, the Bank’s governor, said. “We are watching and will continue to watch these risks very carefully.”
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Fears are growing that the world is splintering as conflicts in Ukraine and the Middle East escalate and Donald Trump, the incoming US president, threatens to impose a barrage of tariffs on imports from countries including China, Mexico and Canada. At the same time, there are worries about vulnerabilities caused by high levels of government borrowing around the world, including in the UK and the US.
“Global risks associated with geopolitical tensions, global fragmentation and pressures on sovereign debt levels remain material,” the committee said in its twice-yearly financial stability report, which assesses threats to Britain’s financial system. “Uncertainty around, and risks to, the outlook have increased.”
Regulators are also worried about threats lurking outside the traditional banking industry.
Tougher capital requirements on banks since the 2008 crisis have pushed some activities away from conventional lenders and fuelled the growth of the so-called shadow banking sector, which encompasses everything from private equity firms to hedge funds.
This area of the system is more opaque and less tightly regulated than mainstream banks and has been at the centre of several market crises in recent years. They include the pension fund meltdown that followed the mini-budget debacle in 2022 and the implosion of Archegos, a family investment office, earlier that year.
Concerns about further blow-ups prompted the Bank to conduct a stress test of Britain’s broader financial system, the first exercise of its kind anywhere in the world. The results of this exercise, which involved market players ranging from hedge funds and pension funds to banks and insurers and simulated a severe shock to the system, were published on Thursday and showed firms risked being “underprepared in a real stress”.
One lesson from the test was potential fragility in the sterling corporate bond market, an important source of funding for British companies that “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”. Another finding was “a significant mismatch in expectations in the gilt repo market” during a crisis.
Separately, the Bank also warned of risks posed by private equity ownership of life insurers.
Britain’s biggest lenders, however, were given a clean bill of health after the results of the annual stress test conducted by Threadneedle Street showed that banks had sufficient capital buffers to weather an economic shock.
Stress tests on banks were introduced in response to the 2008 crisis and typically have been carried out annually. However, the Bank said that in future the test will be undertaken every other year and that other supplementary assessments will take place in the intervening years.