The Prudential Regulation Authority has urged banks to stress test their private equity exposure as it found very few lenders carry out comprehensive stress testing exercises, said Rebecca Jackson, executive director of authorisations, regtech and international supervision at the Bank of England.
Speaking at a UK Finance conference today, Jackson said the PRA, which is part of the BoE, had presented the results of a thematic review launched last August of the adequacy of banks’ risk management frameworks in relation to their exposure to private equity.
“There were gaps, and often significant gaps, identified in most of the frameworks that we assessed. Nevertheless, there is a great deal of variation across firms, with some demonstrating significantly more developed practices and having clear remediation plans for gaps, while at the other extreme, some firms had almost no ability to aggregate data or even appreciate its crucial importance,” she added.
Given how the private equity market has developed over the past decade, such findings are “disappointing”, said Jackson.
“We found a creeping sense of complacency among firms, especially in relation to the large and growing business of subscription financing, due to a lack of loss history in this type of business,” she said.
Assets under management within the private equity sector have grown from around $2tn to $8tn over the last decade and there has been an explosion in the complexity of financing products that banks now provide to the private equity industry, the review found.
Different parts of a bank’s business may potentially be related to private equity. Corporate banking divisions might offer subscription financing lines; investment banking units may originate leveraged financing underwriting exposures; corporate banking units may hold leveraged loan portfolios; and global markets units might provide derivatives hedging solutions.
The regulator has sent letters to the banks that participated in the review, suggesting expectations of what effective risk management requires in light of the review.
