Private equity needs to manage risk better, says Bank of England

London — Risk management in the private equity sector needs improving, 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 twice-yearly Financial Stability Report that the 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 looked at stock market valuations of Britain’s lenders after concern from 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,” the report said. Market-wide factors, such as differences in economic outlooks and “market depth” were significant drivers of bank valuations in Britain, it added.

“The FPC will continue to monitor developments in UK banks’ market valuations, including in comparison with international peers,” the BoE said.

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 is anticipated 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 so-called 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%, the bank said.

The bank also set out the initial findings of its first system-wide exploratory scenario or SWES, which tested the effect of theoretical shocks affecting different 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.

After the near-meltdown in the UK government bond market in September 2022, liquidity buffers of market participants are now well above regulatory minimum levels.

A second leg of the test is now being rolled out with overall results published in the fourth quarter.

Reuters