LONDON, June 20, 2023 (BSS/AFP) - The Bank of England on Monday launched a new stress test that will for the first time cover non-banking financial institutions, which played a role in recent UK markets turmoil.

So-called shadow banking institutions -- including hedge funds, pension funds and insurers -- will face a system-wide "exploration exercise" to assess the risks that they pose to stability, the BoE said in a statement.

"The exercise aims to improve understanding of the behaviours of banks and non-bank financial institutions in stressed financial market conditions," it added.

"It will explore how those behaviours might interact to amplify shocks in UK financial markets that are core to UK financial stability."

After the 2008 global financial crisis, central banks imposed regular stress tests on major commercial lenders to test their ability to withstand another sector-wide meltdown and avoid further costly banking bailouts.

The BoE has repeatedly stated that it is satisfied with Britain's top banks.

However, London markets have faced shocks in recent years as a result of the shadow banking sector.

The BoE recently estimated that such institutions represent about half of total assets lent by the global financial system.

Non-banking finance players face less regulation than traditional lenders.

The industry played a key role in UK bond market chaos late last year.

The BoE was forced to buy UK debt in September 2022 in an emergency intervention to avert financial catastrophe, after a controversial tax-slashing budget by the short-lived government of ex-prime minister Liz Truss caused bond yields to soar and sparked panic.

Some pension funds use Liability Driven Investments (LDIs), which are linked to financial derivatives and intended to help ensure that the income generated by the assets covers their long-term commitments.

However, the chaos caused the value of assets, notably government bonds, to dive and yields to jump.

"We regularly run scenario exercises with a variety of firms which support our efforts to protect and enhance the stability of the UK financial system," said Jon Cunliffe, the BoE's deputy governor for financial stability.

"The launch of this exercise will provide valuable insight into the system-wide dynamics for banks and non-banks following a severe but plausible stress to financial markets."

After UK markets calmed in the wake of Rishi Sunak replacing Truss as prime minister, bond yields have resumed their rise.

The yield on Britain's two-year bond jumped above five percent Monday, striking a level last seen during the 2008 global financial crisis.

It comes with the Bank of England set to raise interest rates once more on Thursday as the central bank struggles to cool stubbornly-high British inflation.