Bank of England Governor Andrew Bailey warned on Wednesday against dismissing recent private credit failures as isolated incidents, saying the sector’s opacity could amplify shocks in a way that was reminiscent of the 2008 financial crisis.
Bailey made the comments, his starkest yet on risks in private credit – lending to companies by non-banks, such as private equity funds and asset managers – in an interview with Reuters.
In February, British mortgage provider Market Financial Solutions (MFS) collapsed, following the twin bankruptcies last year of U.S. auto parts supplier First Brands and car dealership Tricolor. Allegations of fraud or mismanagement have been made in all three cases.
The failures have rattled investors and fuelled concerns about lending standards across wider credit markets, prompting debate over whether problems in the roughly $2 trillion market are one-offs or will turn into a systemic issue.
Speaking at the British central bank’s London headquarters, Bailey said a key feature of private credit was that it was “fairly opaque”. That lack of transparency could turn seemingly isolated failures into broader stress if investors began to suspect problems were more widespread than previously thought.
“If you then learn there is a lemon – it’s called a failure – you lose confidence in the whole system, because you say ‘there’s more lemons in there than I thought, more weak companies in there than I thought, and I don’t know where they are'” Bailey said, recalling how a loss of confidence had intensified the 2008 crisis.
“I’m not saying it’s going to happen,” he added. “But we’ve had this experience before, so we have to watch for this.”
PRIVATE CREDIT DEBATE HAS ECHOES OF PRE-2008 SUBPRIME
While Britain’s domestic private credit market is smaller than that of the United States, risks could not be viewed in isolation because of the global nature of the financial system, Bailey said.
He pushed back against complacency. “Quite a few people have said to me, it’s fraud, it’s idiosyncratic … don’t read too much into it. Well, that’s a judgment,” he said.
The debate over whether recent failures were isolated echoed early arguments ahead of the 2008 financial crisis.
“It sort of takes me back to the financial crisis for a moment,” Bailey said, recalling how policymakers had initially focused on whether problems in the U.S. subprime mortgage market were large or systemic enough to trigger wider turmoil. At the time, he said, “a lot of people concluded, no, it wasn’t on its own. It wasn’t big enough to cause it.”
“That doesn’t look like a very good call in retrospect now,” Bailey added.
STRESS TEST
The BoE launched a first-of-its-kind stress test of the private credit sector in December, which aims to examine interlinkages with the banking system and whether it exacerbates stress and risks to financial stability.
Because private credit firms are not regulated by the central bank, participation in the exercise is voluntary.
Bailey said firms had been very cooperative and that the industry was “keen to be a part of this process”. The BoE will publish the names of participating firms on Thursday and has previously said it will set out interim findings from the test in the middle of the year.
GILT MARKET MOVES ORDERLY BUT STRETCHED
British government bond yields have surged in recent weeks, with the conflict in Iran fuelling inflation concerns and pushing 10-year yields to their highest since 2008.
Bailey described recent moves in the gilt market – some of the sharpest in years – as “orderly but stretched”.
“We’ve seen nothing that set our alarm bells ringing,” he added. “We watch it hourly, frankly, because of the importance of it.”
Structural changes in government bond markets over the past five years, with hedge funds absorbing a much larger share of new sovereign debt issuance, had increased vulnerability, he said.
“That has enabled, frankly, many governments to issue more debt, but it does make the system more prone to these quite rapid and volatile moves that we are seeing when we face a shock,” Bailey said.
The real risk, he said, is if the war endures. A prolonged period of high energy prices and disrupted energy supplies will strain policy in many countries “quite seriously”.
(Editing by Catherine Evans)
