Private equity sector needs to manage risk better, says BoE
• United Kingdom central bank’s report on investigation shows that higher borrowing costs are posing challenges
Risk management in the private equity sector needs to be improved, particularly as the period of low interest rates leads to higher financing costs in the highly leveraged industry, the Bank of England (BoE) said on Thursday.
The BoE said in its twiceyearly Financial Stability Report that an investigation of the sector showed it was facing challenges from higher borrowing costs.
“Improved transparency over valuation practices and overall levels of leverage would help reduce the vulnerabilities in the sector,” the bank said.
“Risk management practices in some parts of the sector need to improve, including among lenders to the sector such as banks.”
The BoE’s financial policy committee said it would consider the results of work being done internally and by the Financial Conduct Authority to address some of these problems.
The report also covered stock market valuations of Britain’s lenders due to the concern of Britain’s Conservative government that they had been lagging those of US rivals. But the BoE found that British banks’ valuations were in line with eurozone peers, and had begun closing the gap with the US.
“The difference in banking sector equity valuation in the UK relative to the US is similar to that of other economic sectors,” said the report.
Market-wide factors, such as differences in economic outlooks and “market depth” were significant drivers of bank valuations in Britain.
“The FPC will continue to monitor developments in UK banks’ market valuations, including in comparison with international peers,” said the BoE.
The BoE said it would also undertake a “desk-based” stress test of Britain’s major banks this year, meaning it would use its own models rather than requesting data from lenders. Aggregate results would come in the fourth quarter of this year. A standard stress test with individual results was expected in 2025.
The UK banking sector had the capacity to support households and businesses, even if economic and financial conditions were to be substantially worse than expected, the FSR said.
The countercyclical capital buffer (CcyB), or “rainy day” buffer of capital on banks that can be drawn on in stressed times, remains at its neutral setting of 2%, said the bank.
The bank also set out the initial findings of its first systemwide exploratory scenario, or SWES, which tested the effect of theoretical shocks affecting various market participants on the UK government bond market.
So far the test showed that liquidity needs rose significantly as margin for backing positions increased, with selling in corporate bonds also rising.
Since the near-meltdown in the UK government’s bond market in September 2022, liquidity buffers of market participants are now well above regulatory minimum levels.
A second leg of the test is being rolled out with overall results published in the fourth quarter.
RISK MANAGEMENT PRACTICES IN SOME PARTS OF THE SECTOR NEED TO IMPROVE, INCLUDING AMONG LENDERS TO SECTOR