BoE too confident about strength of major Tier 1 FX liquidity providers

BoE’s very generic statement does not take into account the potential curtailment of counterparty credit to OTC FX brokers. Tread with care!

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Today, the Bank of England has stated that the UK’s lenders were strong enough to weather the rest of the coronavirus storm – even if unemployment soared to 15%.

On its own, that is a bold statement, and perhaps the layman can rest easy, however what about the FX brokerage sector?

The FPC today said that “a range of near-term risks” remain. They include market volatility resulting from draconian Covid related restrictions; the transition to life outside the EU; and geopolitical risks.

That is far too generic, and a much more detailed picture needs to be looked at.

If credit does not get extended by major banks – FinanceFeeds is aware that most mainstream Tier 1 banks are not allowing new business bank accounts to be opened – and fear of the default of existing lending sets in, where does this leave the counterparty credit agreements that are extended by the same banks to OTC derivatives companies?

The Bank of England said today that UK firms have raised over £75 billion in additional financing from banks and markets during Covid. It said this was “in large part through government-backed loan schemes”.

BoE figures show that borrowing in the summer was much lower than in the spring, although it ticked up in August. This extra lending puts banks in a very exposed position, as business is very much in recession globally, hence the risk of a percentage of companies that have borrowed that extra £75 billion go bankrupt, the banks will never see that lending repaid, and will have their own balance sheets weakened tremendously.

This will likely have a knock on effect to liquidity takers, as banks will not have the resources or risk appetite to extend counterparty credit, which is quite difficult to maintain as it is.

Some companies have reported that banks are making it more difficult to borrow through coronavirus loan schemes. MPs have said banks need to support struggling firms.

The FPC’s financial stability report said banks were strong enough to keep up Covid lending. “The UK banking system remains resilient to a very wide range of possible economic outcomes,” it said. “It has the capacity to continue to support households and businesses.”

The FPC warned that “cutting support to the economy to avoid the use of capital buffers would be costly for the wider economy and consequently for the banks themselves”. It said banks’ capital buffers “exist to be drawn down in stress”.

This is a relatively muted warning sign that banks are over exposing themselves, with existing customers, realizing that they are at a crossroads in terms of underwriting. Do they stop lending and allow existing clients to go bankrupt and not pay existing debts, or do they continue lending in the hope that some will survive and others will not?

This possible ideology is backed up by there being a curb on new business with most UK banks, whether you are looking for a bank account for a small business, or a dealing account with the Tier 1 FX desk.

Combined with the higher volatility, this dynamic makes a good case for further use of non-bank market makers which have become the darling of the OTC derivatives world in terms of highest level liquidity provision over recent years.

Given this, it is likely that the b-book trade warehousing model is very much alive and well, and for those wishing to operate on an agency basis, trades are more likely to be sent to non bank market makers rather than over-encumbered banks who are putting a brave face on a very dark storm.

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