The Bank of England was forced to buy 19 billion pounds of British government bonds in late September and early October after sharp moves in the gold market left some pension funds facing collapse. A jump in borrowing costs in the wake of former chancellor Kwasi Kwarteng’s micro-budget has left many funds that used Liabilities Based Investment (LDI) strategies struggling to meet huge cash demands.
The incident led to greater scrutiny of how the shadow banking sector is regulated. It has grown in size since the 2008 financial crisis, as the rules governing the banking sector have tightened significantly.
Ms Breeden said more needed to be done to improve transparency in the non-bank sector, which is worth tens of trillions of dollars. The lack of transparency resulted in the collapse of Archegos Capital Management last year. The hedge fund had built up huge hidden leveraged positions using derivatives that were only revealed when it collapsed. As a result, more than $100bn (£88bn) was wiped off the value of almost a dozen companies.
Market reforms could include forcing investors to hold more money to meet emergency cash calls, Ms. Breeden said, which would help “ensure that excessive leverage is better controlled by market prices and profit margin”.
Ms Breeden said the regulation of money managers should be closer to that of the banking sector, where stress tests force lenders to battle through sharp falls in house prices to ensure they have enough capital to cover potential losses. .
Last month, former prime minister Gordon Brown called for “eternal vigilance over what has happened in the so-called shadow banking sector”, warning that “there could be further crises”.
Separately, Bank of England chief economist Huw Pill said on Monday that a bigger tax hike from Jeremy Hunt in next week’s autumn statement could soften the interest rate blow facing households.
He told a public Q&A session that raising taxes was “another way of reducing demand” and could lower the top for interest rates as the Bank tries to contain inflation running at a four-decade high.
“We would put interest rates a bit lower, accelerate the economy, boost spending through monetary policy to offset that effect and still ensure that inflation returns to 2%,” he said, discussing a scenario where the chancellor raises taxes more than the Bank expects.
The gloomy economic forecasts published by the Bank last week included no assumptions about future fiscal policy as Mr Hunt tries to plug a hole of more than £50bn through tax rises and spending cuts.
The Bank will be able to respond to the Chancellor’s Budget announcements on 17 November at its next scheduled meeting in December.
