Secular stagnation could pose a risk to the UK’s financial stability as a result of actions being taken to close funding gaps in defined benefit (DB) schemes, according to staff at the Bank of England.

Writing in a blog for staff of the central bank, Frank Eich, who works in the bank’s international surveillance division, and Jumana Saleheen, head of division in the financial stability directorate, argued that a prolonged period of weak growth and low interest rates could increase funding shortfalls at UK DB schemes by pushing up liabilities.

While the direct effects would be limited, financial stability could be affected indirectly by an intensified “search for yield” as pension funds seek higher returns to close funding gaps, according to Eich and Salaheen.

This could drive prices higher in infrastructure or commercial real estate, they said.

The shift to generally less generous defined contribution (DC) pension provision could also push up asset prices if individuals react to this also by looking for yield, for example by buying property.

Eich and Salaheen also argued that the search for yield could be affected by corporates’ investment capacity, if they are forced to inject cash into pension schemes.

“Of course this does not mean that the money would no longer be available for investment,” they wrote. “What it does mean though is that the pension scheme rather than the corporate sponsor would invest the available funds, potentially pursuing a different asset mix.”

Despite these concerns, Eich and Saleheen said individual cases of large deficits were unlikely to pose a financial stability risk to the UK.

“The normal course of events would be for a UK corporate sponsor to agree with the Pensions Regulator on how to close a funding gap over time,” wrote Eich and Saleheen. “Closing this gap might affect dividend payments or wage settlements but should in practice pose few financial stability risks.”

They added that financial stability was unlikely to be affected if a corporate sponsor went into administration. In most cases, its pension scheme would be taken on by the Pension Protection Fund (PPF). The only time a financial stability risk would appear, the authors said, would be if the sponsor “is itself a financial company whose demise might pose financial stability risks or we are in the midst of a wider economic and financial crisis”.

In its February inflation report the Bank of England said aggregate investment growth had not been materially affected by companies’ DB pension fund deficits.

In its recent green paper on the sustainability of DB schemes the UK government suggested fears of an “affordability crisis” were overblown, as evidence was “far from being conclusive, and should be considered with caution”.

This has been criticised, or at least questioned, by some, and welcomed by others.

The blog post by Eich and Saleheen can be found here.

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