Bank of England’s Concerns with Private Equity Financing: Key Points and Next Steps [co-author: William Adams]

The Bank of England’s Financial Policy Committee (FPC) and the Prudential Regulation Authority (PRA) have raised concerns about the evolution of private equity financing and the banking sector’s exposure to the private equity industry. In a series of speeches and a thematic review, the regulators highlighted the growth of the private equity industry and the increasing complexity of financing arrangements.

Over the past decade, the private equity industry has seen significant growth, with assets under management reaching $8 trillion. This growth has been fueled by low interest rates, leading to a shift in the financing of the industry. Private equity funds are now highly leveraged vehicles, with a rise in “upstream” and “midstream” lending, as well as the use of private credit funds for lending to portfolio companies.

The PRA’s thematic review found that banks were struggling to identify and measure their exposure to the private equity sector due to siloed risk management processes. Banks were also lacking independent credit and counterparty risk management procedures to assess risks comprehensively. The PRA emphasized the need for banks to improve their data aggregation, credit due diligence, stress testing frameworks, and board level reporting to manage their exposure effectively.

Chief Risk Officers at banks have been tasked with reviewing the findings of the review and assessing their risk framework against the key findings. They are required to report back to their board risk committees and share the analysis results with the PRA by August 30, 2024.

The regulators’ concerns highlight the need for banks to enhance their risk management processes and address the complexities of their exposure to the private equity industry. As the private equity sector continues to grow and evolve, it is crucial for banks to adapt and strengthen their risk frameworks to mitigate potential risks.