Shocks and Shields: How Resilient Is the UK Financial System in 2024?

The Bank of England’s latest Financial Stability Report (November 2024) serves as a masterclass in understanding the delicate balancing act of safeguarding a nation’s economy. Beneath its meticulous analysis lies a vivid portrait of how financial systems weather storms—and why students of economics should pay close attention.

Financial markets are facing a paradox. Risk premia—the extra return investors demand for taking on risk—are hovering near historic lows. This might sound like a good thing for stability, but here’s the catch: low risk premia often precede sharp corrections in asset prices. When sentiment shifts, it’s like pulling a thread from a sweater; markets can unravel quickly. A sudden repricing could push up borrowing costs, especially for businesses relying on market-based finance.

For students exploring asset markets, this raises critical questions: What drives these low-risk premia? How do they tie to monetary policy and geopolitical uncertainty? The answers lie in understanding investor behaviour amid global uncertainty—from tensions in the Middle East to the evolving economic power-play between the U.S. and China.

Household Debt: Resilience Amid Rising Rates

One highlight of the report is the improving resilience of UK households. Despite a modest rise in mortgage interest rates, most households are holding steady. However, about 50% of borrowers may face refinancing challenges in the next three years. As future economists, this is your cue to examine how monetary policy influences household spending and borrowing.

Moreover, smaller businesses—the backbone of the UK economy—face tougher times. Higher interest rates mean tighter profit margins, especially for firms with leveraged positions - in other words, a lot of debt. What could this mean for employment, and how might this ripple through the broader economy?

The Climate-Resilience Conundrum

No discussion of economic resilience is complete without addressing climate change. The report dedicates a section to the systemic risks posed by extreme weather and the transition to net-zero emissions. For instance, rising flood risks could render properties uninsured, leading to falling house prices and rising defaults. This isn’t just about environmental policy; it’s about how economic systems adapt to long-term challenges.

Students can ponder this: How do you balance immediate economic needs with investments in climate resilience? And what lessons can developed economies like the UK offer to many emerging low and middle-income nations grappling with more severe climate risks?

The Bigger Picture: Global Interconnections

In a hyper-globalised world, the UK is not and can never be immune to external shocks. Vulnerabilities in China’s property market, for example, have far-reaching implications. The Bank of England’s stress tests—which included scenarios like a 49% drop in UK commercial property prices—show how intertwined domestic and global risks are.

Economics students should delve into these global dynamics. What happens when a downturn in one region affects supply chains or investment flows worldwide? How do banks and non-bank financial institutions shield themselves—and the economy—from these shocks?

Takeaways for Aspiring Economists

The Financial Policy Committee (FPC) has its hands full managing a plethora of risks—from market volatility to geopolitical unrest. But as the report shows, resilience is not just about reacting to crises; it’s about preparing for the unpredictable.

For students, this report is an invitation to think critically about systemic risk, the trade-offs in policy decisions, and the role of financial institutions in ensuring stability. It’s a call to action for the next generation to innovate, analyse, and make economics not just a field of study, but a tool for shaping a resilient future.

Glossary:

1. Risk Premia: The extra return investors require for taking on higher risk.
2. Market-Based Finance: Non-bank financial systems that provide credit, such as bonds or equity markets.
3. Stress Test: Simulated scenarios to assess the resilience of financial institutions under adverse economic conditions.
4. Geopolitical Risk: Economic and market risks arising from political instability or conflicts.
5. Transition Risk: Financial risks associated with the shift to a low-carbon economy.
6. Net-Zero Emissions: Achieving a balance between the greenhouse gases emitted and those removed from the atmosphere.

Key Data Summary:

• Household Resilience: Mortgage arrears remain low, despite rising rates.
• Corporate Challenges: Refinancing pressures loom for smaller businesses.
• Stress Test Results: UK banks resilient even under severe global downturn scenarios.
• Climate Impact: Up to 7% of UK households could face unaffordable insurance by 2039.
• Global Sovereign Debt: Public debt-to-GDP ratios continue to rise globally, approaching 100% by 2030.

Retrieval Questions for A-Level Students:

1. What is risk premia, and why does its current level pose a concern for financial stability?
2. How does climate change pose risks to the UK’s financial system?
3. What are the implications of rising public debt-to-GDP ratios for global economic stability?
4. Why are UK households considered resilient, despite rising mortgage rates?
5. How does geopolitical risk affect global financial markets?