Again, a simple thought experiment is illustrative: counterparty credit risk, unanticipated margin call and the scale of margin related liquidity flows around the system would have been greater and destabilising had the pandemic struck ten years ago. So if the banking and derivatives markets reforms operated broadly as intended can we conclude that the financial system as whole has – so far – functioned well and proved resilient in the current crisis? Here the judgement is more difficult. We have not seen systemic bank failures, credit crunches or ballooning counterparty credit risks. But we have seen a massive liquidity shock and incipient dysfunction in core financial markets that required central bank intervention on an unprecedented scale. 11  Ben Bernanke has pointed out that panics can be a major cause of credit crunches. Reforms that avoid such panic reduce the likelihood that financial stress transmits to real economy stress. 9  All speeches are available online at www.bankofengland.co.uk/news/speeches  9  It is arguable, as I noted at the outset, that the extreme liquidity shock was simply a function of the scale of the economic impact of the COVID crisis, and the central bank response a necessary and unavoidable consequence of a tail event. Supported by central bank intervention, markets have certainly stabilised.12 Indeed, some seem to have fully recovered their pre-crisis levels. I would reiterate, however, that the crisis is far from over and further negative COVID19 developments could cause financial instability to return.
In contrast, the UK banking system has, I have noted, so far been able to absorb the initial surge in demand for credit from firms6 and extend payment holidays to households. The FPC stress test indicates that banks have the resilience to continue to maintain credit to the real economy. Admittedly, given the risk around economic prospects and the impact on firms, much of the additional lending that is necessary needs to be supported by government guarantee. But we would be dealing with a very different credit environment now absent the resilience – both capital and liquidity – that has resulted from the post crisis reforms. The FPC stress test also illustrates one of the key lessons of the great financial crisis, that if banks have resilience and can use it to help to maintain credit in the real economy in a stress rather than deleveraging, the outcome is in the end better for banks themselves. The capital they might preserve by deleveraging is 4  Since the 2008/09 financial crisis, the Bank has increased the range of collateral it accepts, which now extends to loans and a wide range of securities. 5 To take a very simplified example: the aggregate CET 1 ratio of major UK banks was around 4.5% in 2007 (compared to over 14% now). A 3.8 percentage point capital drawdown (the drawdown we expect banks to face in the MPC’s illustrative scenario) would have depleted a very significant fraction of the capital banks had available.