UK banks and firms involved in the private credit market have been asked to stress-test their systems against a “severe but plausible” scenario where the world economy plunges into a deep global recession.
The Bank of England set out how it will test the resilience of the market after warnings about its potential threat to the wider economy.
A group of 46 firms active in the private credit and private equity market will take part, including banks, pension funds, insurers and asset managers.
As part of the exercise, they will have to model the impacts of a hypothetical scenario and how they would respond to the stress.
The scenario involves a global macroeconomic shock lasting five years, in which supply chains are disrupted, leading to a shortage of hardware components for the tech sector, and energy prices rise sharply.
This leads to deep recession which sees UK inflation rise to 7%, interest rates hiked to 7% and the unemployment rate peaking at 7.5%.
The Bank specified that under this scenario, the technology sector is severely impacted, and artificial intelligence (AI) development is hit by higher energy prices and hardware shortages.
The interim findings from the first stage of testing will be shared later this year, and a final report will be published in 2027.
The Bank asserted that the scenario was purely hypothetical and it was not forecasting such a shock.
But the stress test was designed to help the central bank identify potential risks linked to the private credit market, which has been subject to much less regulation and oversight than the traditional banking system.
This is despite total assets in private credit and equity funds soaring to 11 trillion dollars (£8.3 trillion) over the past decade.
Concerns about the strength of the industry came to the fore last year following the collapses of US auto parts firm First Brands and car dealer and lender Tricolor.
Private credit is a form of lending where businesses do not go to banks but to a private company and negotiate a deal.
Private equity typically refers to financing in return for a stake in a business.
