The Bank of England has announced a comprehensive examination of potential risks stemming from the opaque private equity sector and has noted subdued valuations of Britain’s largest banks compared to global counterparts.

During its quarterly meeting in March, the central bank’s financial policy committee highlighted concerns regarding finance provided to riskier corporates, which could be particularly susceptible to adverse shifts in investor risk sentiment. The private equity sector, closely intertwined with private credit and leveraged lending, has been instrumental in channeling funds into the UK’s real economy, experiencing significant growth over the past decade amid low interest rates.

However, recent increases in interest rates have posed challenges for private equity funds in raising investments, leading to downward pressure on asset valuations and heightened default rates on debt linked to private equity ventures. The opaque nature of asset valuations and leverage within the sector complicates the assessment of broader financial stability risks, prompting the FPC to announce plans for a comprehensive review of these risks in the upcoming June financial stability report.

Despite these concerns, the committee affirmed the UK banking system’s robustness, highlighting its strong capitalization and ample liquidity. Major banks such as NatWest, Lloyds, HSBC, and Barclays maintain substantial core equity capital buffers and liquidity coverage ratios, ensuring their capacity to continue lending even under adverse economic and financial conditions.

To further assess the resilience of lenders, the central bank will conduct a “desk-based” stress test this year. Additionally, it plans to maintain the countercyclical capital buffer for major UK banks at its neutral level of 2%.

While overall profitability of major banks is projected to remain sturdy, the FPC noted that indicators of market value reflecting future profitability, such as average tangible price-to-book ratios, remain subdued. This observation underscores ongoing monitoring efforts to ensure the resilience and stability of the UK banking system amidst evolving market dynamics.