UK Regulators Warn Banks to Monitor Private Equity Investments Closely

UK regulators have cautioned banks to closely monitor their private equity investments to avoid potential significant losses. The Bank of England conducted a review and found that banks are routinely unable to measure their overall credit and counterparty risk from their ties to the fast-growing private equity sector. As a result, banks have been given until the end of August to fill gaps in how they manage their private equity exposures.

The regulators are concerned about the risks banks are running due to their increasing involvement in the private equity market. Nathanaël Benjamin, the Bank of England's executive director for financial stability, strategy and risk, stated that many UK companies, both large and small, now rely on private equity funding and complex or opaque financial structures. He warned that a shock to the private equity sector, driven by investor losses or decreased appetite for private assets, could limit companies' ability to access financing, leading to cutbacks in investment and employment.

Why this matters: The private equity market has grown significantly over the past decade, with banks' exposures to the sector also increasing. The lack of data about the risks of a private equity downturn is adding to the uncertainty and potential for severe, unexpected losses at banks.

The Prudential Regulation Authority (PRA) recently conducted a thematic review of banks' private equity-related exposures and risk management practices. The review found that exposures and revenues in banks have grown considerably as they provide various financing products and services to the private equity industry, including upstream lending, NAV loans, and secured financing facilities. However, only a small number of banks can consistently aggregate data in a manner appropriate to their exposures to the private equity sector. Significant gaps were identified in most banks' risk management frameworks.

Rebecca Jackson, a senior executive at the Bank of England, said there is a "creeping sense of complacency" among lenders, who have almost no ability to gather data on their exposure to the private equity sector, despite a boom in loans and financing to the industry. The Bank has given UK lenders four months to get a handle on their dealings with private equity businesses, saying they will have to report back to the regulator by 30 August.

The PRA has urged banks to stress test their private equity exposure, as it found very few lenders carry out comprehensive stress testing exercises. The regulator has sent letters to the participating banks, suggesting expectations for effective risk management in light of the review findings. Benjamin noted that private equity is particularly vulnerable due to its extensive use of leverage and the illiquid nature of its investments. The Bank of England has ordered the banks to tighten up their risk management practices, including the ability to aggregate data on private equity-related activities and conduct regular internal stress tests to gauge potential losses from the sector.

Key Takeaways

• UK regulators warn banks to closely monitor private equity investments to avoid losses.
• Banks lack data to measure credit and counterparty risks from private equity exposure.
• Shock to private equity sector could limit companies' access to financing and investment.
• Regulator finds gaps in banks' risk management of private equity-related activities.
• Banks ordered to improve data aggregation, stress testing, and risk management for private equity.