BoE rebukes UK banks over failure to learn lessons of Archegos collapse

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The Bank of England has criticised UK banks for failing to heed its warnings and take action across their businesses to address the flaws in risk management systems exposed by the Archegos hedge fund scandal.

In a letter sent to major lenders on Monday, the BoE said it had directed them to make improvements to their markets businesses in December 2021, months after the investment firm Archegos failed due to highly leveraged bets that went wrong.

The instruction followed a review by the central bank that found weaknesses in risk management processes had contributed to more than $10bn in collective losses resulting from the Archegos collapse.

It also comes as regulators across the world warn about the heightened risks to markets as economies continue to adjust to an era of raised interest rates.

“It is disappointing that the messages we communicated previously have not been fully addressed,” the BoE wrote.

It also pointed to the UK gilts crisis last year as evidence that “there is still some way to go in applying these lessons to fixed-income businesses”.

The BoE was forced to intervene with a £65bn bond-buying programme to halt plummeting UK gilt prices in September 2022, after the then-government’s “mini” Budget triggered a sell-off by highly leveraged pension fund vehicles, known as LDIs (liability driven investments).

The debacle led the central bank to expand a planned review of banks’ fixed-income businesses to look at the broader issues exposed by the LDI crisis.

Announcing the review’s findings, the BoE said it found a “number of shortcomings” in risk management of individual clients — known as counterparty risk — as well as failures around the “margining arrangements”, which determine how much clients owe at any given time.

It stressed that it expected companies to “extend enhanced credit due diligence principles, client disclosure standards, and counterparty risk management controls beyond those that have been introduced for hedge fund clients in equity financing”.

These should be expanded to “all client types in all secured financing and other relevant trading businesses”.

On the subject of counterparty risk, the BoE said many banks had made “insufficient attempts” to work out how concentrated their risks were to clients and collateral.

It added that some lenders had failed to establish “formal controls” to limit exposures to clients or types of assets and called for action in response.

“With the recent shifts in the global macro environment, firms should enhance the way they assess their trading and counterparty risks, incorporating new and broader stresses into their risk management processes,” the BoE wrote.

On margining, the BoE criticised lenders for “inadequate” monitoring of certain types of risk, alongside their failure to have clear policies on, for example, the discounts they apply to collateral pledged with the bank.

The letter was sent by BoE head of international supervision Nathanaël Benjamin and head of UK deposit takers David Bailey.