Bank of England warns of growing financial risks from trade war

The Bank of England has warned that escalating trade wars, geopolitical instability and rising global debt levels are amplifying risks to the UK’s financial system.

Officials cited the country’s vulnerability due to its “open economy and large financial sector,” according to the World Bank’s latest financial stability report.

Andrew Bailey, the bank’s governor, highlighted the uncertain environment, saying: “We live in a more uncertain world on a number of fronts. We are monitoring these risks very carefully.”

Key concerns include the fragmentation of global trade as conflicts intensify in Ukraine and the Middle East, and as the United States considers imposing tariffs on countries such as China, Mexico and Canada. High government debt in countries such as the United Kingdom and the United States also poses major vulnerabilities.

The report identified increasing risks outside traditional banking, especially in the shadow banking sector, which includes private equity firms and hedge funds. The sector has been linked to market crises, such as the 2022 pension fund turmoil and the collapse of Archegos earlier that year.

To address these risks, the bank conducted the world’s first stress test of the UK’s wider financial system, simulating a severe market shock across banks, hedge funds, pension funds and insurance companies. The results revealed potential fragility in the sterling corporate bond market and a mismatch of expectations in the gilt repo market, indicating vulnerabilities during periods of financial stress.

While Britain’s largest banks have passed separate annual stress tests with adequate capital buffers, the bank announced that these assessments will now take place every two years, with supplementary assessments in the intervening years.

The bank also cited concerns about private equity ownership of life insurance companies, warning that it could pose additional systemic risks.

Despite these challenges, the report reaffirmed the resilience of traditional banking institutions. However, as global uncertainty increases, the Bank’s scrutiny of less regulated financial sectors highlights the evolving complexity of protecting financial stability in the UK.