Treasury lacks awareness of the dangers posed by a shadow banking bubble, Lords caution

Peers Criticize Treasury Over Shadow Banking Risks

An influential House of Lords committee has sharply criticized Treasury ministers for not fully recognizing the dangers posed by the expanding shadow banking sector on Wall Street.

On Thursday, the Lords’ financial services regulation committee expressed serious concerns about the Government’s “limited understanding” of the threats that the surge in private markets could pose to the stability of the financial system.

The committee’s report described the Treasury’s approach as “passive,” which was particularly troubling given the potential consequences for the UK’s financial security from shadow banking and the growth of private markets.

The rapid expansion of private credit—corporate loans issued by non-bank lenders—has sparked fears about its resilience and the possible fallout for the broader economy if a crisis were to occur.

Concerns Over Lending Standards

Last year, worries about declining lending standards intensified after the collapse of two American companies: First Brands, a car parts manufacturer, and Tricolor, a subprime auto lender.

Jamie Dimon, CEO of JPMorgan, cautioned that more problems could surface due to years of relaxed lending practices.

Calls for Greater Treasury Involvement

Lord Hollick, a committee member and former head of UBM, emphasized the need for the Treasury to take a more active role: “The Treasury must show curiosity and take initiative in investigating these issues and sharing their perspective, especially since significant amounts of savers’ money, including pension and insurance funds, are involved.”

He added, “While we hope nothing goes wrong, the scale and significance of these markets mean the Treasury should pay close attention.”

Bank of England’s Response and Ongoing Uncertainty

The committee commended the Bank of England, under Andrew Bailey’s leadership, for its efforts, but noted that the Treasury seemed to rely too heavily on the Bank and was not sufficiently engaged itself.

The report also highlighted a lack of sufficient data to determine whether private markets represent a systemic risk to the financial system.

Notably, the Bank of England was praised for its initiative to launch the world’s first stress test of the shadow banking sector to assess its resilience to global shocks. This assessment will take place in two phases, with findings expected in early 2027.

Growth of Private Markets in the UK

Stricter regulations imposed on banks after the financial crisis have made them more robust, but have also shifted some traditional lending activities into less regulated areas outside the banking sector.

According to the report, the UK’s private market has expanded by 56% since 2015, reaching $185 billion (£138 billion), making it the second largest globally after the United States.

The Treasury has been approached for a response.