Bank of England to stress test private markets

The Bank of England (BoE) has outlined plans for a stress test focused on the resilience of private markets, highlighting concerns around private credit following the high-profile collapses of First Brands and Tricolor. It told Alternative Credit Investor it will begin the exercise this Thursday (4 December).

In its latest Financial Stability Report, the Bank said that while private markets have been resilient to date, they have “not been tested through a broad-based macroeconomic stress at their current size”.

To address this, the BoE will conduct a “system-wide exploratory scenario” (SWES) focusing on potential risks from the private markets ecosystem.

The stress test will aim to:

Explore risks and dynamics associated with private market finance through understanding the actions taken by banks and non-bank financial institutions (NBFIs) active in private markets in response to a shock, and how these actions may interact at a system level
Understand whether these interactions can amplify stress across the financial system and pose risks to UK financial stability and the provision of finance to the UK economy

“The SWES will improve the Bank’s understanding of the behaviours of banks and NBFIs active in the private markets ecosystem in response to a downturn, and whether those behaviours will amplify stress across the financial system and pose risks to UK financial stability,” it said in the report, adding that the exercise “is not a test of the resilience of the firms that participate”.

“Private markets have grown significantly in the UK over the past two decades and are an important source of funding for corporates,” it said. “While resilient to date, the private markets ecosystem has not been tested through a broad-based macroeconomic stress at its current size.

“In order to enhance understanding of the broader risks and dynamics of private markets, the Financial Policy Committee (FPC) supports the next system-wide exploratory scenario (SWES), focused on the resilience of the private markets ecosystem.”

The Bank highlighted concerns around potential weaknesses in “risky credit markets”, including high leverage, weak underwriting standards, opacity, complex structures, and the degree of reliance on credit rating agencies.

“Credit spreads remain compressed by historical standards. Two recent high-profile corporate defaults [First Brands and Tricolor] in the US have intensified focus on potential weaknesses in risky credit markets previously flagged by the FPC,” it said.

“While the impact of these specific defaults has been limited, a diverse range of financial market participants were exposed.”

The private credit market is expected to be worth around £14.8tn by 2028, with around £1.2tn of that in the UK, according to the latest estimates by the Financial Conduct Authority.

However, the sector has come under increased scrutiny of late, due to US auto parts supplier First Brands and auto lender Tricolor collapsing amid allegations of fraud, leaving lenders including banks out of pocket. Most industry onlookers predict increased defaults over the coming year amid worsening macroeconomic conditions but the question is how well the private credit industry weathers the storm.

“The Alternative Credit Council welcomes the Bank of England’s announcement of the private markets SWES exercise,” said Jiří Król, deputy chief executive of AIMA and global head of the Alternative Credit Council, an industry body.

“With public interest in private markets growing, this exercise offers a timely and constructive way to build a clearer evidence base around how the sector, and other parts of the corporate finance markets, might respond under severe but plausible stress,” he added.

“Leading member firms have voluntarily agreed to participate, demonstrating the industry’s responsible approach to transparency, risk management, and maintaining trust in a rapidly expanding source of financing for the real economy.“

The BoE has been contacted for further comment.