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Britain’s central bank to evaluate banks’ readiness on dealing with illiquid markets

British banks will be subjected to rigorous stress tests by the country's central bank to evaluate their readiness on mass sale of bonds by investors in delicate market situations.

Regulators are speculating that investors might want to hurriedly sell off their bonds when interest rates rise, resulting in huge price swings due to lack of liquidity or inventory capacity.

Bank of England (BoE) deputy governor Andrew Bailey was quoted by Reuters as saying that in volatile situations, banks could play a role in boosting market liquidity by stepping in themselves.

The concern came amid huge swings in US Treasuries and the Swiss franc.

Bailey said: "In order to enhance our protection against this risk, in this year’s Bank of England concurrent stress test, we are taking a substantial step to enhance the coverage of market risks."

Banks have been blaming tougher regulation for reducing their inventories of bonds for trading.

However, Bailey further said that inventories had reached more normal levels with the global bond market having grown to $90tn from $30tn in 2000.

BoE’s Financial Policy Committee will be supervising the fragile liquidity in an interim report for June.

Regulators have also been looking into whether automated trading with computer programs are being controlled properly as well as studying options for controlling risks from asset managers by providing short-term redemptions to investors against potentially illiquid assets, reported Reuters.