Adaptation is to mitigation what Robin is to Batman

Jenny Clark and Theresa Löber

The UK’s climate continues to change, getting wetter and warmer, with extremes becoming ever more pronounced. Even if we limit global warming to 1.5°C above pre-industrial levels, experts warn that we’ll see the number and severity of extreme weather events increase further. Without adaptation, we will see more property, infrastructure and agriculture damaged or destroyed, with devastating consequences to households, communities and businesses – as well as increasing risks to economic and financial stability. To date there has been relatively more focus on mitigation and the transition to net zero than on adaptation and addressing physical risk, across both government and the private sector. Adaptation is mitigation’s sidekick, we need them to consistently work together to achieve better outcomes. Much like Batman and Robin.

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Weathering the storm: the economic impact of floods and the role of adaptation

Rebecca Mari and Matteo Ficarra.

Floods are the most costly natural disaster in Europe. In the UK, they account for around GBP1.4 billion in annual losses. Yet, evidence on the macroeconomic implications is inconclusive. GDP often shows a puzzling delayed response, and prices can be pushed in opposite directions. Using a novel county level data set for England for the years 1998–2021, we estimate the impact of flooding on output and inflation at the sector level. Sectors react heterogeneously to floods, which explains well aggregate evidence. Prices respond in sectors related to both headline and core inflation, which has crucial implications for monetary policy. We further show that investing in flood defences mitigates the economic burden of floods by strongly reducing the risk of flooding.

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30+ year mortgages – are these the new norm? What does this mean for financial stability?

James Waddell and Meghna Shrestha

An increasing number of households in the UK are opting for longer-term mortgages, with the share of borrowers taking out new mortgages with terms 30 years or longer tripling since 2005. But who are these households, why have they done so, and what could this imply for financial stability?

This blog presents some analysis to answer these questions, and focuses on three potential risk channels which could affect financial stability. These can be broadly classified into: (i) lending into old age; (ii) increased leverage; and (iii) higher debt persistence. We judge the risks associated with longer-term mortgages are limited and are mitigated by existing Financial Policy Committee (FPC) and Financial Conduct Authority (FCA) policies, which limit risky lending both at the borrower level and in aggregate.

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Long-term fixed-rate mortgages through an international lens: could they lead to higher home ownership?

Gabija Zemaityte

The Tony Blair Institute for Global Change, among others, has argued that long-term fixed-rate mortgages (LTFRMs) could increase home ownership in the UK. The share of mortgages with longer fixes increased in the UK and internationally over the last decade. Persistently low interest rates over that period have supported demand for longer-fix products, including five-year fixes. But differences in mortgage markets structures across countries are the main drivers of the prevalence of LTFRMs – here defined as mortgages with interest rates fixed for 10 years or more. In this post, I review the international experience, and argue that while LTFRMs can guard against interest rate risk, they do not necessarily increase home ownership. Indeed, some economies with high shares of LTFRMs exhibit lower home ownership.

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Sharing interest rate risk: who is trading and what affects the costs?

Ioana Neamțu, Umang Khetan, Jian Li and Ishita Sen

What do the 2023 Silicon Valley Bank collapse and the 2022 UK pension fund crisis have in common? Interest rate risk. Several sectors in the economy run significant asset-liability mismatch that makes them vulnerable to rapid interest rate changes: pension funds and insurers have short-term cash flows and long-term liabilities, while banks follow a lend-long-borrow-short approach. While interest rate derivatives enable risk transfers to hedge these exposures, research on this market is limited, leaving important questions on the extent of risk sharing and the consequences of imbalances unanswered. We construct the largest data set on interest rate swaps using confidential Bank of England data to unlock insights into how investors use these instruments, and their relative importance in determining swap prices.

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Shining a light on private equity backed corporates in four findings

Neha Bora, Sarah Burkinshaw, Alice Crundwell and Tuli Saha

Private equity (PE) has rapidly become an important source of financing for UK businesses. Funds use pools of capital, largely from institutional investors, to primarily invest in non-publicly traded companies. We shed light on this growing sector with a new and novel data set of around 9,000 privately backed corporates in the UK. These corporates employ over two million people, with business activity concentrated in London and in certain sectors such as information and communications. We find that they are relatively more vulnerable to default than all other corporates, and they are financed with relatively larger proportions of shorter tenor debt, like private credit and leveraged loans.

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We are not an island: how have the UK’s external balance sheet risks changed over the past two decades?

Colm Manning and Alice Crundwell

No country is an island – in terms of economics at least, if not geography. Trade and capital link all the economies of the world. Relative to GDP, the UK has more foreign assets and liabilities than any other large economy. These external liabilities – UK assets owned by overseas investors – could result in vulnerabilities that might cause major disruption to the economy and financial system in a stress. The good news for us is that the UK’s private sector external vulnerabilities have shrunk materially since the global financial crisis (GFC) of 2008, although the public sector’s vulnerabilities have grown. This post explores how the UK’s balance sheet has changed since the GFC and what this means for UK financial stability.

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A simple model of the effects of entity and activity constraints on alternative investment funds

Leo Fernandes, Harkeerit Kalsi, Nicholas Vause, Matthew Downer, Sarah Ek and Sebastian Maxted

Hedge funds and other alternative investment funds (AIFs) often take positions in financial markets that significantly exceed their investors’ capital by using debt or derivatives. However, such ‘leverage’ can pose risks to financial stability. Regulators seeking to reduce these risks may consider applying constraints to the fund entities or the activities in which they engage. In this post, we use a simple portfolio choice model to examine the effects of the two approaches on fund investments. Under the entity-based approach, we find that fund managers substitute from lower-risk to higher-risk investments, whereas an activity-based approach can avoid this unintended reallocation by targeting specific investments.

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A summary measure for UK households’ resilience

Vania Esady and Stephen Burgess

A summary measure for UK households’ resilience

High levels of household debt have been shown to amplify recessions. For example, in the global financial crisis (GFC), UK households with more debt tended to cut back their spending disproportionately, amplifying aggregate demand effects and potentially making the recession worse. High levels of household (and corporate) debt can pose risks to the UK financial system through two main channels: lender resilience and borrower resilience. However, monitoring households’ resilience to future shocks is not an easy task. In this post we construct some new summary measures of borrower resilience. We show that increases in debt-servicing costs or in the flow of credit to households could make households less resilient overall.

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Growth-at-Risk for macroprudential policy stance assessment: a survey

Tihana Škrinjarić

How effective is macroprudential policy and how should policymakers measure its stance? My recent paper surveys the literature on the topic of Growth-at-Risk (GaR), which has been developed as a methodology to provide answers to these questions by relating the effects of macroprudential policy tools to real-economy dynamics. While the results are mixed, the consensus finds a positive impact from macroprudential policy tightening during the expansion of the financial cycle. Policy loosening reduces the potential GDP losses during contractions, with the effects being more prominent in the medium term. Several challenges within this framework still exist. Resolving these would lead to a more accurate evaluation of macroprudential policy effectiveness. Finally, I discuss GaR policy applications.

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