Bank of England criticizes lenders for failing to deal with bond market risks

Liz Truss's unfunded tax cut spooked markets, sending UK government bond yields soaring. Photo: Geoff Pugh

The Bank of England has been criticized by creditors for failing to tackle risks in the bond market following last year's turmoil caused by Liz Truss' mini-budget.

In a letter to major creditors, the Prudential Regulation Authority (PRA) said that the banks went bankrupt. heed warnings and take action to improve their risk management systems.

The warning came just a day after yields on 30-year bonds, known as gold bonds, hit their highest levels in Britain since 1998 following a global rout that also sent borrowing costs higher in the US, Italy and Germany.< /p>

The PRA said it was “disappointing” that some lenders had failed to address shortcomings in managing clients' risks following the crisis caused last year by so-called liability-driven investing (LDI).

LDIs are used by pension schemes to protect against adverse inflation fluctuations and help them match their liabilities with their assets.

The review also found that weaknesses in lenders' risk management led to losses of more than $10 billion (£8.2 billion) from the collapse of hedge fund Archegos in 2021.

The ill-fated mini-budget -zhi Truss included a package of unfunded tax cuts that spooked markets, sent UK government bond yields soaring and forced the Bank to intervene.

The PRA said: “In this review, we found a number of weaknesses in firms' counterparty risk management processes… some of our observations are drawn directly from lessons learned from the stressful gold bond market event, but others represent broader themes drawn from our review of the global activities in this area of ​​business.»

The PRA said it had previously advised banks in December 2021 to review their secured finance business and improve risk management.

He added: “However, as companies' experiences during the 2022 gold bond market stress event associated with LDI funds showed, there is still some way to apply these lessons to fixed income finance businesses.

“It is disappointing that the reports we previously reported were not fully addressed.”

Analysts at Barclays warned on Thursday that the rise in bond yields, which is driving up government borrowing costs, will only end after a long downturn. on stock markets.

U.K. 30-year bond yields hit a 25-year high of 5.115% on Wednesday, according to Refinitiv data. Profitability fluctuates inversely with price.

Stocks are struggling under the weight of rising bond market yields. Yields, which are the income paid to bond buyers, rise when bond prices fall as investors demand higher returns.

Higher yields push down stock prices, diverting investment from stocks to bonds as profits. appear to be more profitable.

Barclays analyst Ajay Rajadhyaksha said the bond rout may not end until equities, dubbed «risk assets,» are repriced.

He said: “There is no magic yield level that will automatically attract enough buyers to trigger a sustained rise in bonds.

“In the short term, we can think of one scenario in which bonds rise substantially. If risk assets fall sharply in the coming weeks.

“The scale of the bond sell-off has been so staggering that, from a valuation perspective, stocks may be higher than they were a month ago.

We believe that the ultimate path to bond stabilization is through further revaluation of lower risk assets.”