The Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank, the Federal Reserve, and the Swiss National Bank are today announcing a coordinated action to further enhance the provision of liquidity via the standing U.S. dollar liquidity swap line arrangements.
To improve the swap lines’ effectiveness in providing U.S. dollar funding, these central banks have agreed to increase the frequency of 7-day maturity operations from weekly to daily. These daily operations will commence on Monday, March 23, 2020 and will continue at least through the end of April. The central banks also will continue to hold weekly 84-day maturity operations.
The swap lines amongst these central banks are available standing facilities and serve as an important liquidity backstop to ease strains in global funding markets, thereby helping to mitigate the effects of such strains on the supply of credit to households and businesses, both domestically and abroad.
The same information appeared on other Central Bank web site too.
The spread of Covid-19 and the measures
being taken to contain the virus will result in an economic shock that
could be sharp and large, but should be temporary. The role of the Bank
of England is to help to meet the needs of UK businesses and households
in dealing with the associated economic disruption.
On 11 March, the Bank of England’s three
policy committees announced a package of measures to support UK
businesses and households through this period. In his Budget on the
same day, the Chancellor of the Exchequer announced a number of fiscal
measures with the same aim. On 17 March, this combined package of
measures was complemented by the announcement by HM Treasury of the
Covid 19 Corporate Financing Facility (CCFF), for which the Bank will
act as HM Treasury’s agent. By purchasing commercial paper, the CCFF
will provide funding to non-financial businesses making a material
contribution to the UK economy to support them in paying salaries, rents
and suppliers while experiencing the likely disruption to cashflows
associated with Covid-19.
In light of actions to tackle the spread of the virus, and evidence relating to the global and domestic economy and financial markets, the Monetary Policy Committee (MPC) held an additional special meeting on 19 March. Over recent days, and in common with a number of other advanced economy bond markets, conditions in the UK gilt market have deteriorated as investors have sought shorter-dated instruments that are closer substitutes for highly liquid central bank reserves. As a consequence, UK and global financial conditions have tightened.
At its special meeting on 19 March, the MPC judged that a further package of measures was warranted to meet its statutory objectives. It therefore voted unanimously to increase the Bank of England’s holdings of UK government bonds and sterling non-financial investment-grade corporate bonds by £200 billion to a total of £645 billion, financed by the issuance of central bank reserves, and to reduce Bank Rate by 15 basis points to 0.1%. The Committee also voted unanimously that the Bank of England should enlarge the TFSME scheme, financed by the issuance of central bank reserves.
The majority of additional asset purchases
will comprise UK government bonds. The purchases announced today will
be completed as soon as is operationally possible, consistent with
improved market functioning. The Bank will issue further guidance to
the market in due course.
The next regularly scheduled MPC meeting
will end on 25 March, with the minutes published on 26 March. The
minutes of today’s special meeting will be released at the same time.
UK Treasury and the Bank are coordinating closely in order to ensure that our initiatives are complementary and that they will, collectively, have maximum impact, consistent with the Bank and HM Treasury’s independent responsibilities.
Although the magnitude of the economic
shock from Covid-19 is highly uncertain, activity is likely to weaken
materially in the United Kingdom over the coming months. Temporary, but
significant, disruptions to supply chains and weaker activity could
challenge cash flows and increase demand for working capital from
companies.
The CCFF will provide funding to
businesses by purchasing commercial paper of up to one-year maturity,
issued by firms making a material contribution to the UK economy. It
will help businesses across a range of sectors to pay wages and
suppliers, even while experiencing severe disruption to cashflows.
The facility will offer financing on terms
comparable to those prevailing in markets in the period before the
Covid-19 economic shock, and will be open to firms that can demonstrate
they were in sound financial health prior to the shock. The facility
will look through temporary impacts on firms’ balance sheets and cash
flows by basing eligibility on firms’ credit ratings prior to the
Covid-19 shock. Businesses do not need to have previously issued
commercial paper in order to participate.
The scheme will operate for at least 12
months and for as long as steps are needed to relieve cash flow
pressures on firms that make a material contribution to the UK economy.
The Bank will publish further details of the operation of the CCFF in a
Market Notice on Wednesday 18 March. The Bank will implement the
facility on behalf of the Treasury and will put it into place as soon as
possible.
By providing an alternative source of
finance for a wide range of companies, the scheme will help to preserve
the capacity of the banking system to lend to other companies, including
small and medium-sized enterprises, which rely on banks. Last week,
the Bank of England boosted this capacity by:
launching a new Term Funding Scheme
with additional incentives for lending to SMEs (TFSME). This will, over
the next 12 months, offer four-year funding to banks of at least 5% of
participants’ stock of real economy lending at interest rates at, or
very close to, Bank Rate. Additional funding will be available for
banks that increase lending, especially to small and medium-sized
enterprises (SMEs).
reducing the UK countercyclical
capital buffer rate to 0% of banks’ exposures to UK borrowers with
immediate effect. This extended banks’ capacity to lend to businesses by
up to £190bn.
Taken together the actions announced by HM
Treasury and the Bank of England will help UK businesses and households
to bridge a temporarily difficult period and thereby to mitigate any
longer-lasting effects of Covid-19 on jobs, growth and the UK economy.
HM Treasury and the Bank will take all
further necessary steps to support the UK economy and financial system,
consistent with its statutory responsibilities.
Overnight the Bank of England cuts the UK cash rate by 0.5% to 0.25%, cut the banks’ liquidity buffer to zero, and announced extra funding for banks to lend to businesses, all in response to the virus. The Prudential Regulation Authority (PRA) said that banks should not increase dividends or other distributions, such as bonuses, in response to these policy actions.
The Bank is coordinating its actions with those of HM Treasury in order to ensure that initiatives are complementary and that they will, collectively, have maximum impact. The Bank continues to co-ordinate closely with international counterparts. We will discuss the budget spend, also announced today in a separate post.
The bank said that although the magnitude of the economic shock from Covid-19 is highly uncertain, activity is likely to weaken materially in the United Kingdom over the coming months. Temporary, but significant, disruptions to supply chains and weaker activity could challenge cash flows and increase demand for short-term credit from households and for working capital from companies. Such issues are likely to be most acute for smaller businesses. This economic shock will affect both demand and supply in the economy.
At its special meeting ending on 10 March
2020, the Monetary Policy Committee (MPC) voted unanimously to reduce
Bank Rate by 50 basis points to 0.25%. The MPC voted unanimously for
the Bank of England to introduce a new Term Funding scheme with
additional incentives for Small and Medium-sized Enterprises (TFSME),
financed by the issuance of central bank reserves. The MPC voted
unanimously to maintain the stock of sterling non-financial
investment-grade corporate bond purchases, financed by the issuance of
central bank reserves, at £10 billion. The Committee also voted
unanimously to maintain the stock of UK government bond purchases,
financed by the issuance of central bank reserves, at £435 billion.
The reduction in Bank Rate will help to
support business and consumer confidence at a difficult time, to bolster
the cash flows of businesses and households, and to reduce the cost,
and to improve the availability, of finance.
When interest rates are low, it is likely
to be difficult for some banks and building societies to reduce deposit
rates much further, which in turn could limit their ability to cut their
lending rates. In order to mitigate these pressures and maximise the
effectiveness of monetary policy, the TFSME will, over the next 12
months, offer four-year funding of at least 5% of participants’ stock of
real economy lending at interest rates at, or very close to, Bank Rate.
Additional funding will be available for banks that increase lending,
especially to small and medium-sized enterprises (SMEs). Experience from
the Term Funding Scheme launched in 2016 suggests that the TFSME could
provide in excess of £100 billion in term funding.
The TFSME will:
help reinforce the transmission of
the reduction in Bank Rate to the real economy to ensure that businesses
and households benefit from the MPC’s actions;
provide participants with a
cost-effective source of funding to support additional lending to the
real economy, providing insurance against adverse conditions in bank
funding markets;
incentivise banks to provide credit to businesses and households to bridge through a period of economic disruption; and
provide additional incentives for
banks to support lending to SMEs that typically bear the brunt of
contractions in the supply of credit during periods of heightened risk
aversion and economic downturns.
To support further the ability of banks to supply the credit needed to bridge a potentially challenging period, the Financial Policy Committee (FPC) has reduced the UK countercyclical capital buffer rate to 0% of banks’ exposures to UK borrowers with immediate effect. The rate had been 1% and had been due to reach 2% by December 2020.
The FPC expects to maintain the 0% rate
for at least 12 months, so that any subsequent increase would not take
effect until March 2022 at the earliest.
Although the disruption arising from Covid-19 could be sharp and large, it should be temporary. Such economic disruption should have less of an impact on the core banking system than recent stress tests run by the Bank have shown the system can withstand. Those stress tests demonstrated that banks would be able to continue to lend to businesses and households even while absorbing the effects of substantial, prolonged economic downturns in both the UK and the global economies, as well as falls in asset prices much larger than experienced in recent weeks.
Given the resilience of the core banking
system, businesses and households should be able to rely on banks to
meet their need for credit to bridge through a period of economic
disruption.
The release of the countercyclical capital buffer will support up to £190 billion of bank lending to businesses. That is equivalent to 13 times banks’ net lending to businesses in 2019. Together with the TFSME, this means that banks should not face obstacles to supplying credit to the UK economy and to meeting the needs of businesses and households through temporary disruption.
The FPC and the Prudential Regulation
Committee (PRC) will monitor closely the response of banks to these
measures as well as the credit conditions faced by UK businesses and
households more generally.
The release of the countercyclical capital
buffer reinforces the expectations of the FPC and the PRC that all
elements of banks’ capital and liquidity buffers can be drawn down as
necessary to support the economy through this temporary shock. In
addition, the Prudential Regulation Authority (PRA) has today set out
its supervisory expectation that banks should not increase dividends or
other distributions, such as bonuses, in response to these policy
actions.
Major UK banks are well able to withstand
severe market disruption. They hold £1 trillion of high-quality liquid
assets, enabling them to meet their maturing obligations for many
months.
In response to the material fall in
government bond yields in recent weeks, the PRC invites requests from
insurance companies to use the flexibility in Solvency II regulations to
recalculate the transitional measures that smooth the impact of market
movements. This will support market functioning.
The Bank of England has operations in place to make loans to banks in all major currencies on a weekly basis. Banks have pre-positioned collateral with the Bank of England enabling them to borrow around £300 billion through these facilities.
The actions announced today by the three
policy committees of the Bank of England comprise a comprehensive and
timely package to allow UK businesses and households to bridge a
temporarily difficult period and thereby to mitigate any longer-lasting
effects of Covid-19 on jobs, growth and the UK economy.
The normal line of argument has been that its central banks pumping liquidity into the financial markets which have led to falling real interest rates, and that they might indeed take them into negative territory. This is all to do with “secular stagnation” (reflecting poor productivity, globalisation, weak wages growth, and monetary policy intervention by central banks).
Last year the IMF in a working paper suggested that a cut of 4% or there abouts would be required to react to a financial crisis similar to the scale of the GFC. That would pull rates deeply negative, and of course so far (Sweden apart) no one has found a way back, as Japan and the Eurozone illustrates.
Many sovereign rates sit in negative territory, and there is an unprecedented $10 trillion in negative-yielding debt. This new interest rate climate has many observers wondering where the bottom truly lies.
Now, most economists are on a quest to return to a “stable positive rate”, eventually, considering negative rates to be there for am emergency, and temporary.
The paper creates a long term global series, weighted by GDP from 1310 to the present day. The series only includes yields which are not contracted short-term, which are not paid in-kind, which are not clearly of an involuntary nature, which are not intra-governmental, and which are made to executive political bodies. In other words, cash lending against annual payments in “chicken” and other commodities, or against leases for offices, against jewellery, land or other real estate with no known equivalent cash value are all excluded.
The GDP weights over time, and the share of advanced economy GDP covered by the series varies as history played out and empires rose and fell.
Data robustness is an issue, as the paper recognises as late medieval and early modern data can of course never be established with the same granularity as modern high-frequency statistics. One still has to rely on interpolations, deal with the peculiarities of early modern finance, and acknowledge that the permanency of wars, disasters, and destitution since medieval times may have irrecoverably destroyed a significant share of the evidence desired. However, the story is pretty clear.
The data here suggests that the “historically implied” safe asset provider long-term real rate stands at 1.56% for the year 2018, which would imply that against the backdrop of inflation targets at 2%, nominal advanced economy rates may no longer rise sustainably above 3.5%. Whatever the precise dominant driver –simply extrapolating such long-term historical trends suggests that negative real rates will not just soon constitute a “new normal” – they will continue to fall constantly. By the late 2020s, global short-term real rates will have reached permanently negative territory. By the second half of this century, global long-term real rates will have followed.
The standard deviation of the real rate – its “volatility” – meanwhile, has shown similar properties over the last 500 years: fluctuations in benchmark real rates are steadily declining, implying that rate levels are set to become both lower, and stickier. But downward-trending absolute levels, and declining volatilities have persisted against a backdrop of a secularly growing importance of public and monetary balance sheets. This would suggest that expansionary monetary and fiscal policy responses designed to raise real interest rates from current levels may at best have a cyclical effect in the longer-term context.
According to the report, another trend has coincided with falling interest rates: declining bond yields. Since the 1300s, global nominal bonds yields have dropped from over 14% to around 2%.
He concludes:
I sought to suggest that a long-term reconstruction of real rate developments points towards key revisions concerning at least two major current debates directly based on – or deriving from – the narrative about long-term capital returns.
First, my new data showed that long-term real rates – be it in the form of private debt, non-marketable loans, or the global sovereign “safe asset” – should always have been expected to hit “zero bounds” around the time of the late 20th and early 21st century, if put into long-term historical context.
In fact, a meaningful – and growing – level of long-term real rates should have been expected to record negative levels. There is little unusual about the current low rate environment which the “secular stagnation” narrative attempts to display as an unusual aberration, linked to equally unusual trend-breaks in savings-investment balances, or productivity measures. To extent that such literature then posits particular policy remedies to address such alleged phenomena, it is found to be fully misleading: the trend fall in real rates has coincided with a steady long-run uptick in public fiscal activity; and it has persisted across a variety of monetary regimes: fiat- and non-fiat, with and without the existence of public monetary institutions.
Secondly, sovereign long-term real rates have been placed into context to other key components of “nonhuman wealth returns” over the (very) long run, including private debt, and real land returns, together with a suggestion that fixed income-linked wealth has historically assumed a meaningful share of private wealth. There is a very high probability, therefore, to suggest that “non-human wealth” returns have by no means been “virtually stable”, only if business investments have both shown an extreme increase in real returns, and an extreme increase in their total wealth share, could the framework be saved.
If compared to real income growth dynamics we equally detect a downward trend across all assets covered in the above discussion.
There is no reason, therefore, to expect rates to “plateau”, to suggest that “the global neutral rate may settle at around 1% over the medium to long run”, or to proclaim that “forecasts that the real rate will remain stuck at or below zero appear unwarranted” as some have suggested.
With regards to policy, very low real rates can be expected to become a permanent and protracted monetary policy problem – but my evidence still does not support those that see an eventual return to “normalized” levels however defined, who contemplate a “nadir” in global real rates in the 2020s): the long-term historical data suggests that, whatever the ultimate driver, or combination of drivers, the forces responsible have been indifferent to monetary or political regimes; they have kept exercising their pull on interest rate levels irrespective of the existence of central banks, (de jure) usury laws, or permanently higher public expenditures. They persisted in what amounted to early modern patrician plutocracies, as well as in modern democratic environments, in periods of low-level feudal Condottieri battles, and in those of professional, mechanized mass warfare.
In the end, then, it was the contemporaries of Jacques Coeur and Konrad von Weinsberg – not those in the financial centres of the 21st century – who had every reason to sound dire predictions about an “endless inegalitarian spiral”. And it was the Welser in early 16th century Nuremberg, or the Strozzi of Florence in the same period, who could have filled their business diaries with reports on the unprecedented “secular stagnation” environment of their days. That they did not do so serves not necessarily to illustrate their lack of economic-theoretical acumen: it should rather put doubt on the meaningfulness of some of today’s concepts.
So negative rates are coming and are here to stay!
Following the monumental Conservative election victory, now is the time for the economics to work through. Mark Carney is due to leave his post as governor of the Bank of England at the end of January after six and a half years in charge, and the chancellor, Sajid Javid, will be choosing a replacement soon – perhaps before Christmas. Via the UK Conversation.
This will be a pivotal decision for the
chancellor – no doubt in close consultation with Boris Johnson and his
advisers. Whoever they pick should not expect a honeymoon period. They
are arriving against the backdrop of Brexit, widening regional inequality and the prospect of a downturn in the global economy.
The frontrunners are said to be Minouche Shafik, director of London School of Economics; Kevin Warsh, a former top official at the US Federal Reserve; and Andrew Bailey, chief executive of UK regulator the Financial Conduct Authority. Add to these names Jon Cunliffe and Ben Broadbent,
both currently deputy governors at the Bank. Behind this sits a couple
of more alternative candidates: Santander chair and former Labour
minister Shriti Vadera and Boris Johnson’s former economic adviser, Gerard Lyons.
An alternative governor may be just the
required medicine at present, since there is a strong case for someone
willing to think differently about central bank management. With
interest rates still very low in the UK and most other developed
economies, there are widespread concerns that central banks will be unable to fight another downturn using the classic response of cutting rates.
Beyond this, there are arguments for
revising the entire model of central banking. In recent years, the trend
has been for them to manage rates without any political interference
and to concentrate purely on keeping inflation low. Indeed, it is almost
30 years to the day since the Reserve Bank of New Zealand became the first central bank to make inflation the sole priority.
In times of inflation, this system made sense. But since the 2007-08 financial crisis, the world has found itself in a situation where economic growth is much weaker and deflation is more of a risk than inflation.
The Bernanke exception
As former Federal Reserve chair Ben Bernanke said in a speech in Tokyo
in 2003, “in the face of inflation … the virtue of an independent
central bank is its ability to say ‘no’ to the government”, but with
protracted deflation of the kind that has continually dogged Japan, “a more cooperative stance” by central banks towards the government is required.
His argument was essentially that it’s
hard to sustain inflation by manipulating interest rates, and that
you’re more likely to be successful using the fiscal levers of
government spending and tax cutting. The same approach is arguably required in the UK today and across the developed world.
Having lost the ability to properly
stimulate the economy using interest rates, the Bank of England and
other central banks have taken it in turns to resort to quantitative
easing – essentially creating money with which to buy mainly government
bonds from banks and other financial institutions. This was supposed to
drive extra liquidity into the economy, but mainly it has just been used
to bid up prices in the likes of the bond market and stock market and
exacerbate the wealth gap.
As an alternative, some commentators are now touting “helicopter money”:
this would involve central banks creating money that would be handed
straight to the public via government tax cuts or public spending – thus
requiring them to coordinate their policies in a way that does not
happen at present.
This could be pursued in conjunction with a novel concept called “modern monetary theory”,
which envisages government targets to boost demand and inflation
financed by a disciplined central bank that keeps interest rates at
zero. We are already seeing signs of the government moving in the same
direction by shifting away from austerity towards more generous spending.
As for the Bank of England’s own targets,
greater policy cooperation with the government would provide wiggle room
for focusing beyond inflation. In particular, the Bank could play a
role in addressing regional inequality. The UK already has the one of the worst rates
of regional inequality in the developed world, with areas like the
north of England and West Midlands bringing up the rear. This will be heightened by leaving the EU, since these same areas are key to international supply chains and expected to be the worst hit.
The answer is for the government to pursue
an industrial policy that aims to improve productivity in regions where
it is weakest, through the likes of targeted tax breaks and economic
development zones, with an accommodating Bank of England providing the
funding to facilitate.
More productive areas attract more capital, which is the reason behind
the north-south divide in the first place. Such an industrial policy
would encourage more investment in these areas, produce real-wage
increases, boost local demand and stimulate regional development. In
short, it would help counteract the impact of Brexit.
Long-term thinking
Two central criteria for the appointment
of the next Bank of England governor stand out. First, they must
understand the deeper economic and social circumstances that have led to
Brexit and the UK’s shift to the right. They must act as governor for
the whole country and not just for London plc: a move away from focusing
on smoothing short-term fluctuations towards prioritising long-term
growth.
Second, the job specification for the next governor says that the candidate should have “acute political sensitivity and awareness”. This might suggest that the government does not want another governor with such outspoken views on say, the economic risks from Brexit. Be that as it may, policy coordination needs to be a priority. I don’t rule out the possibility of the leading candidates being able to work like this, but I worry that they will be too orthodox for the challenge. The government should recognise the shifting sands in central bank policy and appoint someone who is willing to lead from the front.
Author: Drew Woodhouse, Lecturer in Economics, Sheffield Hallam University
The Bank of England released a discussion paper and scenarios for the finance sector to consider the risks of climate change (whatever the cause). They conclude that financial assets are at risk and these risks need to be recognised and accounted for.
According to the Bank of England, climate change creates risks to both the safety and soundness of individual firms and to the stability of the financial system. These risks are already starting to crystallise, and have the potential to increase substantially in the future. There is a pressing need for central banks, regulators and financial firms to accelerate their capacity to assess and manage these risks.
So, the Bank of England has published a discussion paper which sets out its proposed framework for the 2021 Biennial Exploratory Scenario (‘BES’) exercise.
The objective of the BES is to
test the resilience of the largest banks and insurers (‘firms’) to the
physical and transition risks associated with different possible climate
scenarios, and the financial system’s exposure more broadly to
climate-related risk.
They say, conducting a climate stress test poses distinct challenges compared to conventional macrofinancial or insurance stress tests. To ensure it is effective in light of these challenges, the Bank is using this discussion paper to consult relevant stakeholders on the design of the exercise. This includes financial firms, climate scientists, economists, other industry experts, and informed stakeholder groups.
Whilst climate-related risks will materialise over decades, actions today will affect the size of those future risks. It is therefore important that firms, and other stakeholders such as the Bank, continue to develop innovative approaches to measure climate-related risks before it is too late to ensure resilience to them. The BES will use exploratory scenarios to size these future risks and to explore how firms might respond to them materialising, rather than testing firms’ capital adequacy.
The key features of the BES are:
Multiple Scenarios that cover climate as well as macro-variables: to test the resilience of the UK’s financial system against the physical and transition risks in three distinct climate scenarios. These range from taking early, late and no additional policy action to meet global climate goals.
Broader participation: both banks and insurers are exposed to climate-related risks, and the action of one will spill over to affect the other. For insurers, this exercise builds on the scenarios developed for this year’s insurance stress test.
Longer time horizon: is needed as climate-related risks crystallise over a much longer timeframe than conventional risks. The BES proposes a modelling horizon of 30 years. This is because climate change, and the policies to mitigate it, will occur over a much longer timeframe than the normal horizon for stress testing. To make these scenarios credible and tractable, the Bank proposes that the BES examine firms’ resilience using fixed balance sheets, focusing on sizing the risks and the scale of business model adjustment required to respond to these risks, rather than testing the adequacy of firms’ capital to absorb those risks.
Counterparty-level modelling: a bottom up, granular analysis of counterparties’ business models split by geographies and sectors is proposed to accurately capture the exposure to climate-related risks.
Output: the Bank will disclose aggregate results of the financial sector’s resilience to climate-related risk rather than individual firms.
The Governor Mark Carney said: “The BES is
a pioneering exercise, which builds on the considerable progress in
addressing climate related risks that has already been made by firms,
central banks and regulators. Climate change will affect the value of
virtually every financial asset; the BES will help ensure the core of
our financial system is resilient to those changes.”
Sarah Breeden the Executive Director
sponsor for climate change said “None of us can know exactly how climate
change will unfold, but we do know that it will create risks to the
financial system. I am excited that this ground-breaking exercise will
for the first time allow us to quantify this risk and so determine the
actions we need to take today if we are to minimise these future risks.”
The Bank is consulting on the design of the exercise and welcomes feedback on the feasibility and the robustness of these proposals from firms, their counterparties, climate scientists, economists and other industry experts by 18 March 2020. The final BES framework will be published in the second half of 2020 and the results of the exercise will be published in 2021.
The Banks concludes, there are many challenges involved in designing such an exercise and this proposal seeks to balance various trade-offs. These include providing a comprehensive description of the potential risks while also creating a tractable exercise for firms, and providing sufficient detail in the scenarios to allow results to be aggregated consistently while also providing scope for firms to assess the risks in a granular way.
The Bank of England (BoE) and Financial Conduct Authority (FCA) have a keen interest in the way that ML is being deployed by financial institutions.
They conducted a joint survey in 2019 to better understand the current use of ML in UK financial services. The survey was sent to almost 300 firms, including banks, credit brokers, e-money institutions, financial market infrastructure firms, investment managers, insurers, non-bank lenders and principal trading firms, with a total of 106 responses received.
In the financial services industry, the application of machine
learning (ML) methods has the potential to improve outcomes for both
businesses and consumers. In recent years, improved software and
hardware as well as increasing volumes of data have accelerated the pace
of ML development. The UK financial sector is beginning to take
advantage of this. The promise of ML is to make financial services and
markets more efficient, accessible and tailored to consumer needs. At
the same time, existing risks may be amplified if governance and
controls do not keep pace with technological developments. More broadly,
ML also raises profound questions around the use of data, complexity of
techniques and the automation of processes, systems and
decision-making.
The survey asked about the nature of deployment of ML, the business
areas where it is used and the maturity of applications. It also
collected information on the technical characteristics of specific ML
use cases. Those included how the models were tested and validated, the
safeguards built into the software, the types of data and methods used,
as well as considerations around benefits, risks, complexity and
governance.
Although the survey findings cannot be considered to be statistically
representative of the entire UK financial system, they do provide
interesting insights.
The key findings of the survey are:
ML is increasingly being used in UK financial services. Two thirds of respondents report they already use it in some form. The median firm uses live ML applications in two business areas and this is expected to more than double within the next three years.
In many cases, ML development has passed the initial development phase, and is entering more advanced stages of deployment. One third of ML applications are used for a considerable share of activities in a specific business area. Deployment is most advanced in the banking and insurance sectors.
From front-office to back-office, ML is now used across a range of business areas. ML is most commonly used in anti-money laundering (AML) and fraud detection as well as in customer-facing applications (eg customer services and marketing). Some firms also use ML in areas such as credit risk management, trade pricing and execution, as well as general insurance pricing and underwriting.
Regulation is not seen as a barrier but some firms stress the need for additional guidance on how to interpret current regulation. Firms do not think regulation is a barrier to ML deployment. The biggest reported constraints are internal to firms, such as legacy IT systems and data limitations. However, firms stressed that additional guidance around how to interpret current regulation could serve as an enabler for ML deployment.
Firms thought that ML does not necessarily create new risks, but could be an amplifier of existing ones. Such risks, for instance ML applications not working as intended, may occur if model validation and governance frameworks do not keep pace with technological developments.
Firms use a variety of safeguards to manage the risks associated with ML. The most common safeguards are alert systems and so-called ‘human-in-the-loop’ mechanisms. These can be useful for flagging if the model does not work as intended (eg. in the case of model drift, which can occur as ML applications are continuously updated and make decisions that are outside their original parameters).
Firms validate ML applications before and after deployment. The most common validation methods are outcome-focused monitoring and testing against benchmarks. However, many firms note that ML validation frameworks still need to evolve in line with the nature, scale and complexity of ML applications.
Firms mostly design and develop ML applications in-house. However, they sometimes rely on third-party providers for the underlying platforms and infrastructure, such as cloud computing.
The majority of users apply their existing model risk management framework to ML applications. But many highlight that these frameworks might have to evolve in line with increasing maturity and sophistication of ML techniques. This was also highlighted in the BoE’s response to the Future of Finance report. In order to foster further conversation around ML innovation, the BoE and the FCA have announced plans to establish a public-private group to explore some of the questions and technical areas covered in this report.
