Bank of England (BOE) is set to carry out first stress test next year to check the strength of investment funds and non-bank financial institutions (NBFI).

Through this move, the BoE aims to avert the recurrence of the near-collapse of UK’s bond market that created havoc for the country’s pension fund industry.

In September this year, the central bank had to interfere in the country’s government bond markets to stabilise the uproar in the pension fund market.   

Steep drops in bond prices have led the pension managers to improve margin calls in derivative-based liability driven investment funds (LDIs), where several benefit pension schemes made their investments.

According to BoE’s Financial Policy Committee (FPC), which supervises the risks in the financial system, the LDI crisis triggered the need for a test to see the way NBFIs act during stresses.

In its half-yearly Financial Stability Report, FPC said: “The Bank will run, for the first time, an exploratory scenario exercise focused on NBFI risks, to inform understanding of these risks and future policy approaches.”

BoE plans to give additional details of the test in the first half of next year.

BoE added: “Tightening financing conditions and greater volatility, alongside a number of economic shocks, have caused long-standing vulnerabilities in market-based finance (MBF) to crystallise in a number of areas over the past three years.

“These episodes underline the need to develop and adopt policy reforms to increase resilience across the system of MBF.”

The central bank has not finalised the participants of the test, which seeks to include the UK government and corporate bond market as well as banks.