Financial stability at the Bank of England

The MPC’s primary objective is price stability and the FPC’s is to contribute to protecting and enhancing UK financial stability (Figure A).^{footnote [10]} Those objectives tend to be complementary – financial stability is a prerequisite for price stability, and vice versa – and both ultimately support economic growth and prosperity.

There are clear benefits from having two separate committees for financial stability and monetary stability. In practice, it allows the FPC and MPC to each focus on the issues and the setting of policy tools that are most relevant for achieving their individual objectives.

But the policy actions at the disposal of one committee to meet its objectives will often affect economic and financial variables relevant to the other. Furthermore, the overlapping nature of many of the transmission channels for both committees’ policy actions means that the interaction between the two can be complex.

The two committees are required, in their respective remits specified by HM Treasury,^{footnote [11]} to explain how they have had regard to the actions of the other Committee in their policymaking. In addition, while their objectives tend to be complementary, there is the potential for policy trade-offs to arise.^{footnote [12]} This box explains how these interactions work in practice.

How the committees take into account each other’s actions

The FPC sets macroprudential policy to maintain financial stability, but it can have indirect effects on factors that are relevant to price stability. And the MPC’s monetary policy can have indirect effects on financial stability. So both committees take account of analysis from Bank staff of how the other committee’s policies could lead them to adapt their own policy stance.

Circumstances may arise in which attempts to keep inflation at the inflation target could exacerbate the development of imbalances that the FPC may judge to represent a potential risk to financial stability. The MPC’s remit letter makes clear that the FPC’s macroprudential tools are the first line of defence against such risks but in these circumstances the MPC could allow inflation to deviate from the target temporarily consistent with its need to have regard to the policy actions of the FPC. The FPC’s remit letter notes that it should ensure co-ordination between monetary and macroprudential policy and note publicly how it has had regard to monetary policy. There is therefore an obvious need for the two committees to stay abreast of each other’s discussions and deliberations.

There are several formal and informal arrangements that enable information to flow freely between the two committees. The common chair of the two committees and their overlapping membership helps to ensure an understanding of the key issues one Committee is facing in the discussions of the other, in an informal way. When appropriate, the overlapping members provide live updates during the respective policy rounds.

Members of both Committees have full access to all relevant briefing materials produced by Bank of England staff, for both the MPC and FPC, and they are invited to attend each other’s staff briefings.

The members of the FPC who are not on the MPC also get briefed after each MPC forecast round. This is important, because the FPC uses the MPC’s central projections for macroeconomic variables as the baseline for its own assessment of risks to the financial system stemming from the economic outlook (eg the FPC’s forecasts of household debt service ratios and corporate interest coverage ratios are based on the latest Monetary Policy Report forecast for unemployment and income growth).

Similarly, members of the MPC who are not on the FPC get briefed on the FPC’s discussions. Again, this matters because the MPC conditions its forecasts on relevant policy actions that the FPC has announced. One channel through which this takes place is through the MPC’s assessment of the cost and availability of credit, and of the impact that changes in the availability of credit have on economic activity and inflation, for example, if the FPC had reduced the UK countercyclical capital buffer to support lending.

There are also joint meetings on topics of shared interest , in order to ensure a shared understating of the financial system and how it is affecting the economy, in which they can jointly steer the path for staff analysis and longer-term research.

The interest of the two committees in the Bank’s balance sheet

The Bank of England’s Executive – supported by its Markets Directorate – is responsible for the day-to-day management of the Bank’s balance sheet. However, both the FPC and the MPC have an interest in how the Bank manages the balance sheet, given it can have material implications for financial stability and price stability.^{footnote [13]}

The MPC has decision-making authority for the deployment of instruments and facilities that are varied over time with the primary intention of affecting overall monetary conditions in order to maintain price stability. This includes, for example, the decision-making around quantitative easing and quantitative tightening in recent years. The Bank implements those decisions. The FPC approves the scope and principles which determine the design of balance sheet facilities to ensure they are effective in ensuring the stability of the UK financial system.

The Bank shares information on its balance sheet with both committees. It consults the MPC on prospective changes to the Bank’s balance sheet operations and the design and operation of any new balance sheet facilities, for whatever purpose, in so far as they may have material and/or enduring implications for monetary policy instruments. It consults the FPC on any material changes to its balance sheet facilities intended to reduce financial stability risks.

In times of stress, the FPC can advise the Bank on the crystallisation of financial stability risks, their nature and the channels through which they can threaten UK financial stability (while respecting the fact that the FPC was not established as a crisis management committee). The FPC can recommend that the Bank takes action to address the specific risks to UK financial stability that it identified.^{footnote [14]}

Lessons from the LDI crisis in 2022 and the failure of Silicon Valley Bank UK in 2023

The arrangements supporting the interaction of the two Committees have been put into practice several times in recent years. Two recent case studies help to bring to life how FPC and MPC interaction works in real-world situations.

In September 2022, a fire sale by LDI funds – triggered by a repricing of assets linked to the announcement of changes to UK fiscal policy – led to severe dysfunction in the gilt market.^{footnote [15]} The FPC was briefed on the market dysfunction and noted the risk to financial stability. It recommended that action be taken to address it, and welcomed the Bank’s plans for temporary and targeted purchases in the gilt market on financial stability grounds at an urgent pace. The Bank also took the decision to postpone gilt sales that the MPC had decided to undertake for monetary policy purposes. The MPC was informed of the market operations before they were implemented. The Bank recommenced the gilt sales associated with quantitative tightening less than a month later.

In March 2023, Silicon Valley Bank (SVB) UK faced a rapid deterioration in liquidity and confidence. The Bank determined – in its capacity as resolution authority – that SVB UK was failing or likely to fail and used its resolution powers to sell SVB UK to a private sector purchaser.^{footnote [16]} This resolution action came at the same time as severe stress at several regional banks in the US and there was the potential for a wider loss of confidence in the global banking system and a tightening in financial conditions, including in the UK. Ahead of the MPC’s policy decision taken on 22 March, the FPC shared its analysis of the developments in the global financial system with the MPC. The FPC made clear that it judged that the UK banking system remained resilient, and was well placed to continue supporting the economy in a wide range of economic scenarios, including in a period of higher interest rates. As a result, there was no need for the MPC to take into account financial stability risks, and it proceeded with its policy decision as normal.^{footnote [17]}