Bank of England criticises UK banks’ risk management systems

The Bank of England has sharply criticised UK lenders for failing to tackle the risk management blind spots exposed by the collapse of a multibillion-dollar hedge fund, the energy price shock and other crises that have rocked financial markets in recent years.

The rebuke, delivered in letters to bank chiefs, highlights the BoE’s growing discomfort about the exposure of traditional financial institutions to the hedge funds, pensions and other non-banking financial institutions that are expected to be ground zero for the next financial crisis.

The letters were published on the day Andrew Griffith, the City minister, vowed to tackle another budding risk in the financial system by bringing forward a comprehensive consultation document on cryptocurrency regulation in “weeks not months”.

Policymakers have been largely sanguine about the impact of soaring inflation, recession and rocketing interest rates on the traditional banking system, which was forced to increase capital levels and overhaul risk management practices after the 2008 financial crisis.

But officials have become concerned that banks are not doing enough to mitigate the risks that could bleed over to them from other corners of the financial markets. The BoE has announced it will undertake a landmark exercise in the coming year to identify potential risks.

“During 2022, the market reaction to Russia’s invasion of Ukraine, and volatility in the nickel and long-dated gilt markets, reinforced the importance of a robust risk culture and sound risk management practices at firms,” the letters stated.

“Despite regular messaging from the PRA (Prudential Regulation Authority) on the subject, these events demonstrated that firms continue to unintentionally accrue large and concentrated exposures to single counterparties, without fully understanding the risks that could arise.”

Officials had already warned banks about deficiencies in their risk management and governance frameworks that were highlighted by the collapse of Archegos Capital, which caused $10bn of trading losses for global banks in 2021.

PRA officials said they expected banks to thoroughly review their exposures and added that the authority would monitor how banks managed those risks, especially from non-bank financial institutions.

In a separate letter sent to insurers, the BoE warned that underwriters’ ability to gauge catastrophe risks such as cyber attacks remained “immature” and could leave them exposed to “outsized losses”. The bank added that it would work with the industry to manage risk better from non-weather related catastrophes.

Appearing before the Treasury select committee on Tuesday, Griffith gave fresh details of the government’s bid to tame risks in the hugely volatile cryptocurrency sector.

The UK will publish two papers in “weeks not months” — one on how to regulate private cryptocurrencies such as Bitcoin and another on central bank digital currency, Griffith said.

He added that the regime would go further than the EU’s long-awaited Markets in Crypto Assets (MICA) regulation by including measures around decentralised finance and that the UK’s approach would be “more agile” than MICA, which has been on the drawing board since 2020.

The objective is to “clearly telegraph the risks” associated with private cryptocurrencies, “but not to legitimise” those that are destructive, he said. He stressed that it was still a question of “if not when” a central bank digital currency is created, and that any such currency would be issued in a way that “wouldn’t allow the government to see” what individuals were spending their money on.

Griffith also defended the more controversial elements of the government’s Edinburgh package of financial services reforms, promising that a review of rules on senior managers’ accountability for failures on their watch would look at issues such as the time to process applications for approvals and how many people are covered by the rules.