Financial stability in the UK could be put at risk if banks fail to assess their exposure to “opaque” private equity firms when lending to the sector, a leading regulator has warned.
In a Treasury Committee hearing, Nathanael Benjamin drew attention to the growing risks that traditional banks face when lending to the non-bank sector, such as private equity, hedge funds and investment funds.
Benjamin, who will be joining the Bank of England’s Financial Policy Committee (FPC), noted UK businesses now get as much funding from the non-bank sector as from traditional lenders.
The rapid growth of the non-bank sector over the past decade has been fuelled by tighter banking regulation and the search for yield in an era of low-interest rates.
“The way in which this sector has grown has built up some imbalances as a result of the low-rate environment,” he said, pointing to a range of “stress events” which have rocked the financial system in recent years.
The Bank of England has already started work to address some of these vulnerabilities. Benjamin pointed to the work the Bank has started with regard to open-ended funds and money-market funds.
Private equity, however, which has grown to be worth $9trn globally, has mostly escaped regulatory attention.
Benjamin cautioned: “There are a number of vulnerabilities which leave it more exposed to higher interest rates, especially if there is a deterioration in the economic outlook and a repricing of credit risk.”
In the past banks which lend to private equity firms have “struggled to avoid large counterparty concentrations,” meaning they are at high risk of spillover effects if something goes wrong.
Benjamin argued banks needed to have a “very clear line of sight to their own exposure to private equity firms” which would enable them to gauge the possible risks.
“It’s very important that the banks get a full picture of the aggregate exposures to those concentrations, across the different aspects of their relationships,” he said.
