The Bank of England on Wednesday told regulators to move fast to toughen rules for funds used by Britain's pension industry which nearly collapsed last year after former Prime Minister Liz's Truss's "mini-budget."
The BoE said Britain's banking system was not at risk from the kind of turmoil that has beset some banks in the United States and Switzerland's Credit Suisse.
But the BoE's Financial Policy Committee called on pension regulators to act "as soon as possible" to mitigate the risks posed by liability-driven investment (LDI) funds.
The BoE was forced to launch a new round of government bond purchases after the announcement by Truss's government of major unfunded tax cuts last September triggered a surge in gilt yields and a spiral of collateral calls and further bond sales.
LDI funds should set aside enough liquidity to ensure they can withstand a surge in government bond yields of at least 250 basis points on top of other protections against market swings, the BoE said on Wednesday.
In practice, LDI funds, which are widely used by pension schemes to ensure payouts to pensioners, will have to permanently hold liquidity buffers of around 300-400 basis points, as they have had to do after the mini-budget crisis.
The FPC also said there is a need to toughen resilience of money market funds, used by companies for day-to-day financing, and UK regulators will publish a consultation paper on MMF regulation later this year.
The central bank will also set out in the second quarter details of its first "exploratory scenario" to investigate how banks and non-banks react collectively to market stresses.
The move is the latest sign of how central banks are taking a closer look at non-banks, which are regulated by securities watchdogs which have traditionally resisted such moves.
But Britain's broader banking sector is well-capitalised and has large liquid asset buffers, and it would be able to continue lending to businesses if interest rates rise further and the economy deteriorates, the FPC said after its March 23 meeting, indicating that no changes to banking rules were needed for now.
The FPC stressed that "all UK banks" have been assessed on their resilience to moves in interest rate rises, including the impact on their holdings of net open bond positions.
"The FPC will continue to monitor developments closely, in particular for the risk that indirect spillovers impact the wider UK financial system," it said, citing possible lasting increases in bank funding costs which rose recently.
The FPC left unchanged the amount of capital banks must set aside to ensure lending to businesses flows unhindered cycle - known as the countercyclical capital buffer (CCB).
Looking at how the British economy is coping with the sharp rise in interest rates since late 2021, the FPC said businesses remained resilient with their debt burdens expected to remain well below previous peaks.
A fall in energy prices and a better outlook for Britain's jobs market meant fewer households were likely to have debt problems caused by the high cost of living than thought in December, it said. (Reporting by Huw Jones and William Schomberg)