Major UK banks are actively pushing for regulatory exemptions that could significantly boost government bond market participation. According to reports from Reuters, Barclays has proposed excluding banks' holdings of unencumbered gilts—those not pledged as collateral—from leverage ratio calculations. The bank estimates this move could encourage lenders to purchase up to £150 billion of additional gilts, reduce average gilt yields by around 20 basis points, and lower the government's annual debt servicing costs by approximately £2.5 billion. Lloyds Banking Group has presented a more conservative assessment, believing regulatory changes could increase gilt demand by around £30 billion and reduce annual government interest costs by at least £1 billion. The Bank of England's upcoming review of bank leverage rules could provide a significant boost to Britain's government bond market and reduce the government's borrowing costs by more than £1 billion annually, according to banking industry estimates. As Lloyds analysts noted, "Supporting the bid for gilt issuance has become a primary concern for the Treasury. A regulatory change that mechanically raises bank gilt demand is politically attractive."
The potential regulatory changes could provide substantial benefits to both the banking sector and government finances. Higher participation by UK banks in the gilt market could provide a more stable domestic investor base and potentially reduce financing costs for the government. Analysts at Lloyds noted that increasing bank demand for gilts could be particularly attractive for the UK Treasury as it seeks to finance rising public expenditure while managing elevated borrowing costs. The central bank is expected to provide an update on its leverage review in its half-yearly Financial Stability Report on Tuesday. The review comes after the Bank of England eased its primary capital requirements in December and follows similar regulatory relaxation in the United States, which intensified competitive pressures on British banks. Britain's government has become increasingly reliant on foreign investors including hedge funds to finance its borrowing, while British banks only hold half as much domestic bank debt as their euro zone peers.
Former regulators have expressed significant concerns about the proposed changes, warning against diluting financial safeguards. According to Reuters, Sam Woods, who recently stepped down as the Bank of England's Deputy Governor for Prudential Regulation, had previously described a blanket exemption for government bonds as a significant and potentially risky change to the regulatory framework. "Exempting all gilts from leverage rules would be a profound — and highly risky — change," Woods told financiers in October. David Aikman, a former Bank of England official who helped design the original leverage rules and now serves at the National Institute of Economic and Social Research, questioned whether exempting gilts addresses the underlying issue. Aikman argued that if leverage requirements have become binding for several major UK banks while risk-weighted capital rules have not, regulators should instead examine whether the risk assessment framework for lending to non-bank financial institutions requires adjustment. He also cautioned that government bonds are not entirely risk-free and pointed to lessons from the euro zone sovereign debt crisis, when close links between banks and government finances amplified financial instability. "The answer isn't to take the batteries out of the fire alarm, but to investigate what's going on, figure out which risk weights have fallen too far and recalibrate those risk weights," Aikman told Reuters.
The central bank is exploring alternative regulatory adjustments that could provide banks with greater balance-sheet flexibility without fundamentally altering the role of leverage requirements as a safeguard against excessive risk-taking. Such an approach could address former regulators' concerns about weakening financial safeguards while still supporting government bond market participation. The Bank of England is conducting its first stress test of private markets to assess how the sector would withstand a major geopolitical shock, reflecting growing regulatory attention on private credit markets and other non-bank financial institutions. Katharine Braddick, Woods' successor as Deputy Governor for Prudential Regulation, is previously a senior Barclays executive, suggesting continuity in the regulatory approach. The BoE is also likely to scrap a cyclical component of the leverage ratio that is unique to UK regulation, as an alternative to the proposed gilt exemption.
The Bank of England is conducting comprehensive reviews of multiple financial market segments to address broader stability concerns. The central bank is also continuing its review of the gilt repurchase market, with a comprehensive update expected in early 2027. In September, it proposed introducing minimum risk margins for gilt repo transactions that are not centrally cleared, with policymakers concerned about concentration among hedge funds employing similar trading strategies. Deputy Governor Sarah Breeden told the ICMA industry conference on May 28 that "doing nothing is not an option" regarding gilt repo market reforms. The findings from the central bank's Financial Stability Report are likely to shape both the outlook for Britain's government bond market and the future direction of UK banking regulation.
