UK’s central bank asked lenders in the European nation to bolster their management of their private equity financing business amid the industry’s growing size and potential effects on the country’s economic stability and financial standing.
The Bank of England’s Prudential Regulation Authority wrote in an April 23 letter addressed to chief risk officers at financial firms that they must ensure that they manage their risks sufficiently, comprehensively, and robustly to control changes that affect the make-up and size of their total exposures, which is seeing an increase in unconventional financing products.
Rebecca Jackson and Charlotte Genken, Executive Directors at the Prudential Regulation Authority wrote:
“Assets under management within the [private equity] sector have grown from around $2 trillion to $8 trillion over the last decade. Banks’ financing activities related to the sector have also expanded over this period. Most recently, we have seen an increase in exposures to various ‘non-traditional’ forms of financing linked to financial sponsors and the PE fund sector in general, such as Net Asset Value (NAV) based loans secured against PE fund assets and facilities backed by Limited Partner (LP) interests.”
The authority’s request to lessen exposures comes after it found that most banks do not have independent credit and counterparty credit risk management and procedures implemented that can identify and record risks from overlapping financial interests linked to private equity clients.
The authority warned that, without a full credit analysis and internal transparency, banks may underestimate their risk of loss if ever multiple private equity portfolio companies suffer distress.
A large number of banks are also lacking in stress testing frameworks, the authority added in its conclusion in its letter.