Bank of England warns of risks associated with private credit and leveraged loans

The Bank of England has warned that private credit and leveraged loan markets are vulnerable to “sharp” revaluations. This is its latest warning about the risks in non-bank financing.

The BOE Financial Policy Committee warned about challenges facing two sectors due to high interest rates, persistent inflation, and increased uncertainties about the long-term outlook.
Andrew Bailey, governor of the BoE, told reporters that “riskier corporate borrowing on financial markets like private credit and leveraged loans is especially vulnerable in this environment.”

His comments come after his financial stability specialists warned that economic fears could lead to “sharp” revaluations in a market which grew up during an era with ultra-low rates.

The FPC stated that despite some improvements in the market conditions, the conflict between Israel and Hamas has increased geopolitical risk.

Bailey said that it was “quite an overstatement” to say that financial institutions outside of regulated banks will cause the next financial crises, but that regulators must now pay “much greater attention” to these institutions because the nonbank financial sector has grown so much since 2007-2008 crash.

He said that hedge funds’ bets ballooning on US government bonds were a cause for concern. They could lead to “significant market volatility” and “tighter lending conditions” if a shock occurs.

According to data from the Bank of England, hedge funds’ bets against Treasuries have increased since the “dash for Cash” in March 2020. During that time, as investors rushed to safe assets, government bonds gained value, causing these bets against Treasuries to quickly unwind.
In recent weeks, US government bond yields have fallen sharply , and the markets are now pricing faster interest rate reductions, relieving pressure on asset values. Bailey stated that he would not place much weight on the fact that there have been certain movements in the past week or two from the perspective of financial stability.

The BoE Governor stressed that policymakers are taking action in the UK to reduce the risk in non-banks. This includes a Consultation, announced on Wednesday by the UK markets regulator about increasing liquidity in UK Money Market Funds.

In October, the BoE recommended that the liquidity requirements for these funds be doubled to reduce the risk of a forced sale of assets similar to the one that caused the UK gilt market crisis of September 2022.

Financial Conduct Authority’s proposals, released on Wednesday, include more than tripling the weekly minimum liquidity requirement for certain funds. The majority of UK funds are located in the EU. However, the EU has not proposed similar measures.

The BoE stated that despite the grim outlook for global financial stability that UK households, businesses, and banks had “generally resisted” a sharp rise in interest rates, and a crippling cost of living crises, and that certain trends regarding the country’s level of debt were improving.

BoE stated that although the full impact of rate increases “has yet to be felt by households, businesses and loan borrowers”, some signs of improvement were evident.

The central bank said that the percentage of households with a high debt burden decreased from 1.8% in the first quarter to 1.4% in the third quarter, adjusted for the cost of living.This was “driven by an earlier than expected improvement in real incomes”.

The Financial Policy Committee has also announced that it will conduct its first study on the impact of artificial intelligent technology on financial stability.