The Bank of England has warned that escalating trade wars, geopolitical instability, and mounting global debt levels are amplifying risks to the UK’s financial system.

Officials noted the country’s vulnerability due to its “open economy with a large financial sector,” according to the Bank’s latest Financial Stability Report.

Andrew Bailey, the Bank’s governor, highlighted the uncertain environment, stating, “We are living in a world that is more uncertain on a number of fronts. We are watching these risks very carefully.”

Key concerns include the fragmentation of global trade as conflicts in Ukraine and the Middle East intensify and as the US considers imposing tariffs on countries such as China, Mexico, and Canada. Rising government debt in nations like the UK and the US also poses significant vulnerabilities.

The report identified increasing risks outside traditional banking, particularly in the shadow banking sector, encompassing private equity firms and hedge funds. The sector has been linked to market crises, such as the 2022 pension fund turmoil and the Archegos collapse earlier that year.

To address these risks, the Bank conducted the world’s first stress test of the UK’s broader financial system, simulating a severe market shock across banks, hedge funds, pension funds, and insurers. The findings revealed potential fragility in the sterling corporate bond market and a mismatch of expectations in the gilt repo market, signalling vulnerabilities during periods of financial stress.

While Britain’s biggest banks passed separate annual stress tests with sufficient capital buffers, the Bank announced that these assessments would now occur biennially, with supplementary evaluations in intervening years.

The Bank also flagged concerns over private equity ownership of life insurers, cautioning that it could pose additional systemic risks.

Despite these challenges, the report reaffirmed the resilience of traditional banking institutions. However, as global uncertainties rise, the Bank’s scrutiny of less-regulated financial sectors underscores the evolving complexity of safeguarding the UK’s financial stability.

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