Banks have been given until the end of August to fill gaps in how they manage their private equity exposures after a Bank of England review found they are running a host of risks.
Banks are routinely unable to measure overall credit and counterparty risk from their ties to the fast-growing private equity sector, the Bank said on 23 April.
A “siloed” approach to risk means many banks are leaving themselves vulnerable should market conditions move against the sector, the Bank found, with many lenders failing to limit their exposure to any one financial sponsor.
Some banks “had performed stress tests solely in the context of individual business unit portfolios”, and “a number of banks’ boards were not specifically informed of the overall scale of combined exposures linked to the [private equity] sector.”
This has led to significant risk management gaps as banks cosy up further to private markets firms through new financing deals such as net-asset-value-based loans secured against private equity fund assets and facilities backed by limited partner interests
“Banks need to better employ group-wide risk data aggregation tools, stress testing capabilities and consolidated management information reporting processes,” Prudential Regulation Authority executive director Rebecca Jackson wrote in a letter to banks.
The PRA said banks must share a benchmarking exercise with their board risk committee and provide this analysis, alongside detailed plans to fix any gaps, to their PRA supervisors by 30 August.
Risks on the rise
Despite the fact that so-called non-bank financial institutions like private markets firms are not supervised by the PRA, they have moved up the regulator’s agenda in recent months as their potential impact on the banking system becomes clearer.
Global private equity assets have quadrupled over the past decade to $8tn, according to McKinsey estimates. Private credit, over which the PRA has expressed particular concern, has reached $2tn.
As ties with banks become closer, but remain hard to quantify, regulators have warned that losses on private equity exposures for mainstream lenders could present a systemic risk.
Banks are providing leverage into the system through credit to private equity funds, sponsors and companies owned by the sector, competing with private credit houses, and a crisis could spill across the market, the PRA has warned.
“The private equity industry is an increasingly important source of revenue and credit risk for banks, which see significant opportunities there,” executive director for financial stability strategy, and risk Nathanaël Benjamin said in a 22 April speech.
“I cannot resist pointing out the ironic contradiction in banks on the one hand worried about the threat from non-bank players, but on the other hand keen to help them leverage themselves up,” Benjamin added. “People who used to work for banks are now competitors, or clients, of banks, often in sectors such as private equity.”
Benjamin said the PRA is “focused on ensuring that the banking sector’s risk management practices keep pace with the evolution in the market. And that banks are adequately protecting themselves in case things go wrong.”