Bank of England Scrutinizes Growing Market for Significant Risk Transfers

British lenders are reportedly concerned that the Bank of England’s scrutiny of significant risk transfers (SRTs), also known as synthetic risk transfers, could slow the growth of the market.

These concerns follow an April 9 letter in which the central bank said it is looking at the SRT market and is requiring lenders to respond within two months to its questions about the market’s liquidity risks, the Financial Times (FT) reported Monday (April 14).

SRTs enable investors to earn regular payments from banks in return for taking on credit risk from the lender’s loan portfolio, according to the report.

The value of SRTs issued by British banks increased from about £20 billion in 2023 ($26.4 billion) to about £30 billion ($39.6 billion) in 2024, according to the report.

“We have identified that for certain financing portfolios, banks have adopted an imprudent approach associated with the recognition of collateral for regulatory capital purposes, resulting in a potential undercapitalization of the risks,” the Bank of England said in its letter.

Some bankers worry that this scrutiny could slow the growth of the SRT market by increasing the cost of financing for investors and decreasing the ability of lenders to use the products and free up capital for more lending, the FT report said.

European banks account for about two-thirds of the SRTs done since 2016, while U.S. banks account for the other one-third, according to the report.

The European Central Bank and the U.S. Federal Reserve have said that they are monitoring the growing use of SRTs, per the report.

In another recent move, the Bank of England said Friday (April 11) that the use of artificial intelligence (AI) in algorithmic trading could exacerbate market volatility and amplify financial instability. The central bank said the widespread use of AI for trading and investing could lead to “herding” behavior that could raise the chance of sudden market drops.

On March 5, the Bank of England’s Prudential Regulation Authority (PRA) said it was weighing an increase to its retail deposits leverage ratio threshold to make sure it covered major banks while giving smaller lenders room to grow before becoming subject to the rule.