‘Systemic shocks should be anticipated’: how will the financial system fare in 2024?

Although interest rates are unlikely to go any higher, risks remain as borrowers will continue to roll off contracts agreed when interest rates were near zero.

Financial regulators were kept on their toes in 2023 as the financial system weathered the worst banking crisis since 2008.

The collapse of Silicon Valley Bank (SVB) in March sent shock waves through the banking sector and hammered home the risks of a sudden shift in monetary policy and financial conditions.

Although there have been no further major blowups, it can take a while for the impact of higher rates to filter through to the economy.

Harvey Knight, partner and UK head of the Financial Services Regulatory Group at Withers warned that the financial system would face “ongoing stresses and strains” stemming from the “definitive shift away from a decade and more of low interest rates”.

“Systemic shocks and individual firm collapses should be anticipated as we go into 2024,” he said.

Regulators reckon the traditional banking system is far more secure than in the run-up to the 2008 crisis thanks to post-crisis reforms.

However, stricter regulation on traditional lenders has pushed risk into less regulated areas of the financial system.

Events like the dash-for-cash in 2020 and the LDI crisis in 2022 showed how risks in niche areas of the financial sector can cause widespread instability.

With those events still fresh in the memory, regulators are trying to get ahead of the issue.

In June, the Bank of England launched its first ‘system-wide‘ stress test to explore risks in the non-bank sector. In October it suggested that money market funds should hold more liquid assets to prevent risks from emerging.

Policymakers are also in the process of designing tools that will enable them to lend directly to pension funds and insurance firms if instability should emerge.

Going into next year Michael Sholem, financial services regulation partner at Macfarlanes, suggested that regulators would be paying close attention to money market funds, liquidity mismatches in open-ended funds and the broader “implications of interest rate movements” on the financial system.

2023 has also been a year in which financial firms have faced scrutiny from a consumer perspective.

The Financial Conduct Authority (FCA) introduced the consumer duty rule this summer, which aims to ensure firms deliver good outcomes for consumers on the quality and price of products and services.

Both banks and investment funds have come under pressure from regulators for not offering customers a fair deal.

Knight suggested that regulators would particularly be keeping an eye on whether firms were repricing products to reflect the higher rate environment.

“Regulators have already taken action against those financial services firms that have not passed on the benefit of higher bank base rate interest rises to their customers and this is a trend we should expect to continue,” he said.


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