Sarah Breeden, the Bank’s deputy governor with responsibility for financial stability, said risky corporate lending “is a business model that has grown up in a low interest rate environment, and we might expect it therefore to be more challenged as we adjust to a higher interest rate environment. We certainly see some challenges as we look ahead”.
She warned of “opacity” in private credit as well as “the slowness in adjusting valuations, and the possibility of leverage on leverage, all of which are warning signs in the context of risk building”.
The Bank has joined financiers including bond giant Pimco, private equity house JC Flowers and ratings agency Moody’s in warning of the risks posed by the boom in private credit, now that higher interest rates appear to be here to stay.
Private credit typically covers loans given directly from institutions such as pension funds or insurers to businesses which are heavily indebted and do not have a credit rating which would allow them to issue tradable bonds.
Investors were tempted to enter the risky market when returns on safer assets were low. However, with the Bank of England raising its base rate from 0.1pc to 5.25pc over the past two years, they can earn healthy rates of interest elsewhere.
“Although there are few signs of stress in these markets so far, a worsening macroeconomic outlook, for example, could cause sharp revaluations of credit risk,” the FPC warned.
“Higher defaults could also reduce investor risk appetite in financial markets and reduce access to financing, including for UK businesses.”
There is also a danger that an episode of “fire-selling and a reduction in risk appetite” could spread through financial institutions.
