The Role of Private Credit and Non-Bank Risks in Financial Stability – Keynote Address by Lee Foulger

Dear all,

I am Lee Foulger, the Director for Financial Stability, Strategy, and Risk at the Bank of England. I would like to express my gratitude for the opportunity to address you, courtesy of AFME and DealCatalyst, and share our approach to maintaining financial stability, particularly focusing on the role of non-banks, specifically private credit markets.

The Bank of England holds a critical financial stability objective, with the Financial Policy Committee (FPC) acting as the UK’s macroprudential authority. The FPC’s duty is to identify, monitor, and mitigate systemic risks to ensure the financial system’s resilience during regular and challenging circumstances.

The non-bank sector, also referred to as market-based finance, has experienced substantial growth since the financial crisis. It now accounts for approximately half of UK and global financial sector assets and has significantly contributed to the increase in lending to UK businesses. Consequently, it is crucial for the non-bank system to withstand shocks without causing further disruptions.

Assessing risks in the non-bank sector poses challenges due to its international scope and diverse business models. Furthermore, compiling data to establish a comprehensive understanding of the sector and its risks presents a significant obstacle.

Our approach, as outlined in a 2022 Financial Stability in Focus report, centres on two types of vulnerabilities. Microfinancial vulnerabilities pertain to the inherent risks in the business models of market participants, such as maturity and liquidity mismatch, and leverage. On the other hand, macrofinancial vulnerabilities are market structure-related risks like market concentration, illiquidity jumps, correlation, and interconnectedness.

These vulnerabilities can affect UK financial stability through three primary channels: via systemically important financial markets integral to the real economy, systemically important financial institutions, and disruptions in vital services like payment and settlement systems.

Regarding private credit markets, they have become an increasingly significant funding source for corporates and real estate, facilitating investment and growth opportunities that might have been challenging to secure through public markets or banks.

However, the recent substantial growth of private credit raises concerns about the sector’s resilience to changes in interest rates and economic conditions. Highly leveraged borrowers, in particular, may face challenges with debt servicing and refinancing in a higher rate environment. Business model risks, such as refinancing practices, valuations, risk management approaches, liquidity, and leverage, must be carefully evaluated to understand their potential impact on systemic markets and institutions.

Furthermore, the interconnectedness of private credit markets with other financial institutions and instruments presents potential challenges. For instance, the lack of data on aggregate leverage across the market makes it difficult to assess the extent to which losses could spill over to banks and other investors.

Hence, ongoing monitoring and assessment of risks from private credit and interconnected markets are essential, although there are notable challenges in obtaining reliable data to do so. Consequently, the FPC will continue to engage with market participants, monitor developments, and further assess these risks in the upcoming Financial Stability Report in June.

In conclusion, the Bank of England acknowledges the significant role played by non-bank finance in providing credit. Despite the shift in the risk environment posing challenges to the non-bank sector and private credit markets, it is imperative to fully comprehend these risks. The Bank is dedicated to closely monitoring the evolving market-based finance landscape and will continue to assess the potential impact on the financial system.

I extend my thanks to my esteemed colleagues and collaborators for their valuable input and assistance in preparing this address.

[1] Financial Stability in Focus: The FPC’s approach to assessing risks in market-based finance. Bank of England
[2] Risks from leverage: how did a small corner of the pensions industry threaten financial stability? − speech by Sarah Breeden. Bank of England
[3] Letter from Charlotte Gerken ‘Feedback on the PRA’s preliminary thematic review work on funded reinsurance arrangements’. Bank of England