Simulation framework assesses sterling MMF liquidity and resilience
A new Bank of England working paper introduces a simulation framework to estimate redemption capacity and failure probability for sterling money market funds. The research highlights that front-loaded redemptions are most destabilising and that resilience gains concentrate around 40% weekly liquid assets.
Unpacking MMF resilience through simulation
The paper develops a forward-looking simulation framework for sterling-denominated money market funds (MMFs) to analyze fund-level liquidity dynamics under various redemption shocks and market-liquidity assumptions.
It introduces two key metrics: redemption capacity, which is the maximum cumulative redemptions a fund can meet, and failure probability, the share of paths where daily liquidity constraints are breached.
The model considers three liquidity settings – frozen markets, government securities sales, and limited certificates of deposit monetization – alongside a policy counterfactual that removes threshold-driven redemption acceleration.
Findings indicate that redemption capacity rises with initial weekly liquid assets (WLA) and stress horizon, with front-loaded redemptions being most destabilizing.
Asset sales improve capacity, but this benefit is highly sensitive to market depth, as effective buffers shrink when secondary market liquidity deteriorates.
The persistent liquidity mismatch
Money market funds (MMFs) inherently face a liquidity mismatch, promising on-demand investor access while holding assets difficult to liquidate quickly under stress.
This vulnerability has been evident in past episodes like the March 2020 'dash for cash' and the Global Financial Crisis, where abrupt redemptions forced funds to sell assets into stressed markets, amplifying financial instability.
Regulatory reforms, such as the US SEC's 2010 MMF reforms and the EU's 2017 Money Market Fund Regulation, introduced liquidity management tools and minimum liquid-asset requirements.
However, recurring stress events and recent interest rate increases continue to highlight persistent liquidity mismatches as a key vulnerability for the sector.
Targeted buffers for stronger MMFs
This study provides actionable insights for ongoing regulatory debates on MMF liquidity, particularly for the FCA's review of sterling MMFs and SEC reforms.
Its finding that resilience gains concentrate around 40% weekly liquid assets offers a concrete calibration point for policymakers.
This suggests that targeted adjustments to minimum liquidity requirements can significantly enhance financial stability without unduly impairing intermediation.