The UK Treasury appears to have a limited understanding of the risks posed by the rapidly expanding shadow banking sector, according to a report by a House of Lords committee. This unregulated industry, which has quadrupled in value from $4 trillion in 2008 to $16 trillion (£12 trillion) today, could be the source of the next financial crisis, the report warns.
The committee’s findings suggest that officials may not be adequately prepared for the potential threats the shadow banking sector poses to the UK’s financial stability. This is particularly concerning given the Treasury’s responsibility for ensuring overall financial stability and preventing taxpayers from having to bail out the financial system.
The report states that the UK, as a global financial centre, is likely to be one of the first countries to feel the fallout from a downturn in the US-dominated shadow banking industry. This largely unregulated sector includes private equity firms, which acquire businesses, and private credit firms that compete with regulated banks to issue loans to companies.
Bank of England Governor Andrew Bailey has previously expressed concerns about the shadow banking sector, drawing parallels to the subprime mortgage crisis that triggered the 2008 financial crisis. The central bank is now set to launch a stress test of the private credit industry to better understand the risks it poses.
The Lords committee’s chair, Michael Forsyth, who served in John Major’s government, said the Bank of England, the Financial Conduct Authority, and the Prudential Regulation Authority were right to be vigilant and monitor the dramatic growth of private markets and its implications for financial stability.
In response, a Treasury spokesperson stated that the government has worked with regulators to significantly increase its focus on the non-bank sector in recent years and has a robust, flexible framework to protect financial stability. The Treasury added that it would respond to the report in due course.
The report’s findings underscore the need for policymakers to closely monitor and address the potential risks posed by the rapidly expanding shadow banking sector, which could have far-reaching consequences for the UK’s financial stability.