Non-bank financial institutions now hold nearly 50% of global assets, up from 40% before the Global Financial Crisis, increasing systemic risks.
The Bank of England introduced the SWES stress test and CNRF liquidity tool to prevent financial shocks from spreading beyond traditional banks.
Andrew Bailey warns that hedge funds, systematic trading, and DeFi create liquidity risks, demanding urgent regulatory adaptation to stabilize markets.
Speaking at The University of Chicago Booth School of Business in London, Bank of England (BoE) Governor Andrew Bailey has warned that financial markets are facing a growing web of risks, with non-bank institutions now holding nearly 50% of global financial assets, a sharp rise from 40% before the Global Financial Crisis (GFC).
Bailey stressed that regulatory oversight needs to evolve as financial risks increasingly originate outside the traditional banking sector. He :
“For the last fifteen years we have increasingly seen the emergence of risks to financial stability originating in the non-bank system.”
“For the last fifteen years we have increasingly seen the emergence of risks to financial stability originating in the non-bank system.”
With hedge funds and systematic trading strategies accelerating the complexity of financial markets, central banks must rethink their approach. The speed at which these funds operate has made the system more vulnerable to liquidity shocks and sudden deleveraging, raising the stakes for global financial stability.
Hedge Funds and Systematic Trading Fuel Market Volatility
The rapid growth of multi-manager hedge funds and systematic trading strategies has introduced new layers of market instability. Many of these funds rely heavily on bank financing, but in periods of stress, they can quickly unwind their positions, amplifying market shocks.
This interconnectedness is particularly concerning. When major hedge funds and high-frequency trading firms follow similar strategies, their actions can become dangerously synchronized. If financial stress emerges, their collective de-risking can trigger self-reinforcing cycles of market instability.
Despite their increasing influence, non-bank financial entities remain less regulated than traditional banks. While the financial crisis led to stricter banking regulations, non-banks continue to operate in relative opacity, leaving regulators with limited visibility into the full extent of potential risks.
BoE’s New Stress Test Targets Non-Bank Risks
In response, BoE has introduced the System-Wide Exploratory Scenario (SWES), a first-of-its-kind stress test designed to assess how financial shocks spread beyond banks. Unlike traditional stress tests focusing on banking liquidity, SWES examines liquidity flows between banks and non-banks and how these interactions can magnify systemic risks.
Bailey highlighted a major flaw in previous liquidity distribution assumptions, referencing the “Heineken Principle.” The belief that central bank liquidity—provided through banks—automatically reaches all parts of the financial system no longer holds. Events like the 2020 “Dash for Cash” and the 2022 Liability-Driven Investment (LDI) crisis revealed that non-banks can struggle to access liquidity in times of crisis.
This liquidity shortfall can force non-banks into fire sales of assets, causing sudden market dysfunction. Addressing these gaps is critical as regulators look for better ways to stabilize financial markets during periods of stress.
New Liquidity Facility to Backstop Non-Bank Crises
To tackle liquidity risks in non-bank financial institutions (NBFIs), the BoE has introduced a Contingent NBFI Repo Facility (CNRF). Unlike traditional liquidity support measures, this is not a standing facility but a contingent tool that activates when market stress threatens financial stability.
“We have developed the Contingent NBFI Repo Facility, or CNRF, to tackle severe disruption in the gilt market that threatens financial stability due to shocks that increase the demand of NBFIs for liquidity,” Bailey said.
“We have developed the Contingent NBFI Repo Facility, or CNRF, to tackle severe disruption in the gilt market that threatens financial stability due to shocks that increase the demand of NBFIs for liquidity,” Bailey said.
The CNRF is designed to assist insurance companies, pension funds, and liability-driven investment (LDI) funds, sectors that have struggled to access liquidity during past crises. By creating this backstop, regulators aim to prevent sudden sell-offs and broader financial contagion.
Bailey’s remarks underscore a growing concern: Decentralized finance () and stablecoins are adding new layers of risk that traditional regulatory frameworks have yet to address. DeFi’s lack of centralized governance and high leverage potential make predicting liquidity flows difficult, especially during crisis scenarios.