Shadow banking collapse would ‘put millions of jobs at risk’

Bank of England

Millions of jobs will be at risk if a surge in lending by so-called shadow banks ends in disaster, a top Bank of England official has warned.

Nathanaël Benjamin, executive director for financial stability, strategy and risk at Threadneedle Street, advised that runaway growth in lending by private equity companies is complex, opaque and potentially risky.

The market has surged in size since the financial crisis, with private equity racing to fill the gaps and secure higher returns after traditional banks cut back.

However, private credit is far less regulated than banking, and the authorities have less idea of the possible pitfalls.

Mr Benjamin said: “With many UK companies (large and small) reliant on private markets for financing, a shock to this sector – driven by investor losses and/or a decreased appetite for private assets – could limit their ability to access the financing they need, which could lead to cutbacks in investment and employment.”

He said that globally, private credit is worth $2 trillion (£1.6 trillion), with private equity investing £250bn in the UK. Together with their supply chains, British companies backed by private equity and venture capital employ 3.5 million people.

Private credit refers to loans which are made by funds and individual businesses, rather than by banks or on the publicly traded bond markets.

The jump in interest rates in the past two years has caught the industry by surprise, leaving indebted companies struggling with higher borrowing costs, and private equity companies stuck with few ways to sell off their assets.

Default rates are rising as businesses fail to refinance or repay their debts.

Mr Benjamin said: “Private equity is particularly vulnerable to this given its extensive use of leverage, and the illiquid nature of its investments.

“Some companies sponsored by private equity have turned to refinancing solutions which delay crystallisation of risks.

“That includes ‘amend and extend’ or ‘payment in kind’ agreements. While these agreements can help smooth through the stress, the risk is that the impact of higher rates is simply delayed, and an extension gives false comfort, increasing credit losses in the future.”

The rise of private credit in part reflects a move away from bank lending in the wake of the financial crisis. However, many banks have subsequently been swept up into the industry by funding parts of private equity – raising new risks as the financial system becomes more complicated.

Mr Benjamin said: “There are natural questions about the risks of these financing arrangements, and the growth in kinds and quantity of leverage, or ‘leverage on leverage’, throughout the ecosystem.

“And I cannot resist pointing out the ironic contradiction in banks, on the one hand worried about the threat from non-bank players, but on the other hand keen to help them leverage themselves up.”

But he conceded the system is opaque, which makes it hard for regulators to fully assess the risks or to identify what would happen in a new crunch.

He added: “To be honest, in the same way as there is a lack of transparency in valuations, more generally data about the impact of private equity on the corporate sector is scarce, and it is difficult to assemble the overall picture.”

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