Bailey warns of ‘urgent need’ to improve resilience in non-bank finance
The Governor of the Bank of England has warned of an “urgent need” to improve the resilience of the sprawling network of financial firms lending beyond the traditional banking sector.
Andrew Bailey said that the financial sector was significantly more robust than it had been before the financial crisis, but warned that regulators still faced risks from so-called market-based finance.
“Just because the banking system is in a far more resilient position now than in the past is no reason to rest on our laurels,” he wrote in an article for the Banker.
“There remains a particular and urgent need to increase resilience in market‑based finance globally given that the sector is very large and fast-growing. It is disparate in nature and opaque in important places, meaning that the international interlinkages are, perhaps unsurprisingly, complex and hard to observe.”
Market-based finance includes a wide range of different firms, such as hedge funds, private credit firms, insurers, and pension funds. The sector has grown rapidly since the financial crisis, as post-crisis regulation pushed riskier forms of lending into murkier corners of the financial sector.
The rise of private credit
According to a report last year from the Financial Stability Board (FSB), non-bank financial institutions account for 51 per cent of total global financial assets.
In recent years regulators have grown increasingly concerned about the risks posed to the wider economy by the opaque interlinkages of market-based finance, particularly after a string of high-profile corporate blow-ups and market meltdowns.
The UK’s bond market meltdown in September 2022 was amplified by liability driven investment strategies in pension funds, while two US firms funded by private finance, First Brands and Tricolor, collapsed last September, drawing attention to the risks of private credit.
The Bank of England’s most recent financial stability report estimated that UK banks had exposure of £173bn to private market funds and corporates backed by financial sponsors, including private equity funds.
But part of the problem with market-based finance is that it is difficult for regulators to get accurate data on the sector.
The Bank of England has launched major initiatives to better understand market-based finance and its connections to the financial sector, including a new system-wide exploratory scenario (SWES) in 2023.
The first SWES was concentrated on the gilt market, but the second – launched in December – will be focused on private markets, and private credit in particular.
“We need a robust understanding of how risks might flow through the financial system in a stress,” Sarah Breeden, deputy governor for financial stability, said when launching the test.