LONDON (Reuters) - Extending bank stress testing to the wider financial system could be the next step by regulators to root out weaknesses that undermine stability, a Bank of England paper said on Wednesday.

The Bank has been conducting its own stress test of banks since the 2007-09 financial crisis, supplementing European Union tests. The aim is to spot flaws in business models and check if lenders are holding enough capital to withstand big market shocks.

The BoE has already spoken about stress testing the asset management sector as well, but in its Quarterly Bulletin published on Wednesday, it went a step further to outline the benefits of system-wide testing given the intimate links between banks and market participants.

"While macroprudential authorities are already engaged in analysis of interconnections between different parts of the financial system, no authority has yet undertaken a comprehensive system-wide stress test," a paper in the bulletin said.


Such a stress test would add clearing houses, hedge funds, insurers and money market funds to the mix.

"Extending the reach of stress testing beyond the core banking sector would help in guarding against any perverse incentives stress tests and broader bank regulation creates for institutions to move activities outside the core banking sector into the so-called 'shadow banking sector'."

The Financial Stability Board, the G20 regulatory task force chaired by BoE Governor Mark Carney, suggested last year that regulators should consider system-wide testing.

The BoE said a paper from the International Monetary Fund next year will suggest a way forward.

(Reporting by Huw Jones; editing by Susan Thomas)

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