A new report published today, ‘Private markets: Unknown unknowns’, by the cross-party House of Lords Financial Services Regulation Committee concludes that there is insufficient data to determine whether the growth of private markets poses a risk to the UK’s financial stability.
Global private markets have grown rapidly. The UK’s position as a global financial centre means it is likely to be the first market to experience the opportunities and risks, particularly those flowing from US private markets.
Post-Global Financial Crisis regulatory reforms, particularly to bank capital and liquidity requirements, have contributed to the growth of private credit, as banks have reduced direct lending to UK companies relative to non-banks.
The Committee says the Bank of England is right to shine a light on the growth of private markets and their interconnectedness with the banking system through the voluntary System Wide Exploratory Scenario. The Bank must work with HM Treasury, the Prudential Regulation Authority, and the Financial Conduct Authority to continue to monitor developments in private markets.
Evidence given to the Committee by HM Treasury demonstrated a limited grasp of the concerns raised by the Committee’s inquiry.
Lord Forsyth of Drumlean, Chair of the House of Lords Financial Services Regulation Committee, said:
“There were too many unknown unknowns to determine whether private markets pose a systemic risk to the UK’s financial stability. Our inquiry sought to shine a light on the implications of the rapid growth of private credit markets.
“The Bank of England, the Financial Conduct Authority, and the Prudential Regulation Authority are right to be vigilant and to monitor the dramatic growth of private markets and the implications for financial stability.
“Post-Global Financial Crisis reforms have altered the UK’s lending landscape to the disadvantage of SMEs.”
Other key findings and recommendations in the report include:
- Reforms introduced after the Global Financial Crisis – particularly bank capital and liquidity regulatory requirements – have, as intended, encouraged the banking system to retreat from riskier lending, leaving certain segments of the economy, including SMEs, less well served by banks.
- Banks are increasingly relying on an ‘originate to distribute’ model of lending, in which private credit plays a significant role.
- The availability of SME finance has been squeezed by a combination of changes to bank capital and the fact that private credit has not entered the SME finance market. Addressing constraints on smaller and specialist banks’ ability to lend could increase the finance available to SMEs, should demand, which has been subdued for some time, increase.
- The growth in collateralised loan obligations and significant risk transfers in the UK may pose a potential risk to the UK’s financial stability. The Bank of England and the Prudential Regulation Authority should pay close attention to the development of these markets.
- Throughout the inquiry, the Committee asked for data from the regulators, academics, and industry trade bodies and firms. However, the Committee was not able to obtain extensive or detailed data on the growth of private markets in the UK, the growth of lending provided by private credit, or the scale of interconnections
between banks and private markets. The Committee is concerned that this might represent a gap in policy and rule makers’ evidence base.
