Bank of England’s Private Markets Stress Test: Systemic Risk Assessment in the $16 Trillion Non-Bank Finance Ecosystem

Despite initial market concerns that these failures might signal systemic problems in private credit, industry analysis suggests they were largely idiosyncratic events driven by company-specific fraud rather than broad market weakness[3][6]. Cambridge Associates, for instance, concluded that “the recent bankruptcies of First Brands and Tricolor do not signal systemic problems in private credit” but rather represent “idiosyncratic, driven by fraud and unique business practices rather than broad market weakness”[3]. Similarly, Goldman Sachs Research noted that “the fact that all of the recent defaults have included allegations of fraud or accounting manipulation suggests that they aren’t simply a consequence of worsening economic conditions and weakening credit quality,” adding that “we aren’t seeing any of the indicators that would normally signal the onset of a broader default cycle”[6]. This nuanced perspective is supported by fundamental metrics showing continued strength in private credit markets, with the weighted-average interest coverage ratio across middle market loans reaching 2.3 at the end of third quarter 2025, up from 2.0 a year earlier, and KBRA forecasting a default rate by volume of 1.5% for the direct lending market in 2025, down from 1.8% in 2024[3][6]. Nevertheless, these failures served as a critical wake-up call for regulators, highlighting the potential for fraud to propagate through complex financing structures and exposing significant gaps in oversight mechanisms for private credit markets, which operate with considerably less transparency than public markets[1][9]. The Bank of England specifically cited these events in its Financial Stability Report, noting that “two recent high-profile corporate defaults [First Brands and Tricolor] in the US have intensified focus on potential weaknesses in risky credit markets previously flagged by the FPC,” while acknowledging that “while the impact of these specific defaults has been limited, a diverse range of financial market participants were exposed”[1][45].

The Tricolor bankruptcy particularly exposed vulnerabilities in collateral management, data integrity, and servicing continuity that have broader implications for asset-backed lenders and investors across the private credit ecosystem[24]. As a “buy here, pay here” subprime auto finance company operating over 60 dealerships primarily in Texas and California, Tricolor’s business model involved both selling vehicles and providing in-house financing directly to customers, creating complex interdependencies between its retail operations and lending activities[21][24]. When warehouse lenders uncovered alleged fraudulent activity at Tricolor in 2025, including double-pledging of collateral and data irregularities in loan tapes, the company’s rapid descent into Chapter 7 bankruptcy left approximately 10,000 vehicles and 100,000 loan accounts as collateral for hundreds of millions in creditor claims[21][24]. This situation exposed critical weaknesses in collateral slippage controls, with unstaffed lots increasing theft and vandalism risks, unclear towing and storage responsibilities draining recoveries, and data integrity issues undermining underwriting and surveillance models[24]. The bankruptcy trustee’s order for lenders like Triumph Financial to cease actions and allow third-party servicer Vervent Inc. to assume control further highlighted the fragility of servicing arrangements during distress events, demonstrating how breaks in payment processing and collections can quickly compound delinquencies and losses, particularly when transfers occur under duress[21][24]. These operational vulnerabilities, combined with the alleged double-pledging of collateral that enabled Tricolor to secure financing from multiple lenders against the same pool of assets, revealed significant gaps in perfection controls and cross-facility reconciliations that could have broader implications for private credit markets where similar collateral management practices may exist[24][29].

Similarly, the First Brands collapse exposed risks associated with complex off-balance sheet financing structures that had been poorly disclosed to investors, with the company relying heavily on supply chain finance arrangements that are historically susceptible to fraud due to the high velocity of relatively small transactions[3][22]. The company’s aggressive acquisition strategy in the aftermarket auto parts industry, combined with opaque off-balance sheet financing, created a situation where the true extent of its leverage and financial vulnerability remained hidden until it was too late for many lenders to exit their positions[3][22]. According to a 9fin analysis, as many as 15 business development companies (BDCs) had exposure to First Brands, with more than half of these being privately held lenders including Monroe Capital Income Plus, which held the largest credit investments totaling $60.1 million as of June 2025[22]. The wide disparity in how different BDCs assessed First Brands’ credit quality—Monroe Capital Income Plus marked the first lien debt at 101.25% while Prospect Capital Corporation pegged the same senior instrument at 92.96%—highlighted the challenges of consistent valuation in private credit markets where standardized pricing mechanisms are absent[22]. These valuation discrepancies, coupled with the fact that many private credit investments lack liquid secondary markets, underscored the potential for significant mark-to-market issues when defaults occur, particularly for private BDCs that may face pressure to adjust their valuations when publicly traded peers report losses[22][41]. The First Brands case also demonstrated how private credit managers with robust due diligence capabilities were able to identify warning signs early—such as abnormally high margins, opaque off-balance sheet financings, and management credibility issues—and largely avoid exposure to the troubled company, suggesting that the ability to conduct deep, ongoing diligence and maintain close relationships with borrowers provides a clear advantage in risk detection and avoidance compared to more traditional credit markets[3][6].

The Bank of England’s System-Wide Exploratory Scenario: Methodology and Scope

The Bank of England’s system-wide exploratory scenario (SWES) exercise represents a sophisticated approach to assessing the resilience of private markets, moving beyond traditional firm-specific stress tests to examine system-wide interactions and potential amplification effects across the financial ecosystem[2][11]. Unlike conventional stress tests that evaluate individual institutions’ capital adequacy, this exploratory scenario is explicitly designed to “improve the Bank’s understanding of the behaviours of banks and NBFIs active in the private markets ecosystem in response to a downturn, and whether those behaviours will amplify stress across the financial system and pose risks to UK financial stability,” as stated in the Bank’s Financial Stability Report[1][45]. The exercise will focus primarily on exploring the resilience of the provision of private market finance to the UK corporate sector, with specific attention to private equity (PE) funds investing in UK corporates, credit supporting these PE-sponsored corporates (including private credit funds and substitutable products such as leveraged loans and high-yield bonds), and private credit funds lending to investment-grade or non-PE-owned corporates[2][13]. This targeted approach reflects the Bank’s recognition that PE-sponsored corporates account for up to 15% of total UK corporate debt and 10% of private sector employment, representing more than two million jobs, and are predominantly financed via alternative lines of credit comprising more than 80% of their debt compared with only 30% for the UK corporate sector at large[2][8].

The SWES exercise will employ a two-round methodology designed to capture system-wide interactions and amplification effects by updating participating firms on the behaviors of other firms and any consequences of those behaviors, while also testing key sensitivities to ensure robust insights and analysis[8][11]. This iterative approach represents a significant advancement over traditional stress testing methodologies, which typically assess institutions in isolation without accounting for the complex feedback loops that can amplify stress during financial crises[33][36]. The Bank plans to launch the stress scenario phase of the SWES exercise in early 2026, following an information-gathering phase designed to address key information gaps on the private markets ecosystem, including the alternative asset manager (AAM) sector, which will inform the design of the stress scenario, its shape, and severity[2][13]. This preparatory phase is critical given the relative opacity of private markets compared to traditional banking, where standardized reporting requirements provide regulators with more comprehensive data for scenario design[9][29]. The Bank has emphasized that the exercise is “not a test of the resilience of the individual firms that will participate in the exercise,” with published material explicitly designed not to provide information on any individual firms, reflecting its system-wide focus on understanding how risks might flow through the financial system rather than assessing specific institutions’ vulnerabilities[8][11]. This distinction is crucial for encouraging participation from major market players while maintaining the confidentiality necessary for candid scenario analysis, particularly in a sector where reputational concerns could otherwise discourage full engagement with the exercise[7][10].

Participation in the SWES exercise includes a comprehensive cross-section of the private markets ecosystem, with major alternative asset managers accounting for around one third of UK PE leveraged buyout activity, around half of UK and global private credit activity to the corporate sector, and around 40% of employment in UK PE-sponsored corporates over the past three years[8][10]. The list of participating firms reads like a who’s who of the private markets industry, including Apollo Global Management, Arcmont Asset Management, Ares Management, Bain Capital, Barings, Blackstone, Carlyle, CD&R, CVC Credit Partners, Goldman Sachs Asset Management, Hayfin Capital Management, Hg, ICG, KKR, Oaktree Capital Management, and Permira[2][10]. This broad participation, which the Alternative Credit Council described as demonstrating “the industry’s responsible approach to transparency, risk management, and maintaining trust in a rapidly expanding source of financing for the real economy,” represents a significant achievement for the Bank of England in securing cooperation from an industry historically resistant to regulatory oversight[1][7]. The exercise will also include large banks providing credit to both private market funds and private equity-sponsored corporates, as well as institutional investors that are the primary providers of capital to private and related public markets, ensuring a holistic view of the ecosystem’s interconnectedness[8][11]. Key actors in the scope of the exercise include institutional investors or limited partners (such as insurers, pension funds, endowments, and foundations) that provide capital supporting PE and PC funds and invest in debt assets issued by PE-sponsored corporates, alternative asset managers that operate PE and PC funds and often manage collateralized loan obligations, and banks that provide leverage directly to PE-sponsored corporates and indirectly via funds[2][13].

The Bank of England has outlined three key questions that the SWES exercise aims to address, reflecting a sophisticated understanding of the potential vulnerabilities within the private markets ecosystem[13][45]. First, the exercise will investigate “what is the impact of a global downturn on UK private markets assets originated by alternative asset managers” and how these assets are managed during stress, including the impact on UK corporates in terms of investment and employment[13]. Second, it will examine “how the allocations of institutional investors to private markets and the willingness of banks to provide financing change during a downturn,” specifically what may cause them to reduce capital provided or not support forbearance during stress[13]. Third, the exercise will assess “to what extent are related and potentially substitutable corporate financing markets (leveraged loans, CLO and high-yield bond markets) likely to function during a stress,” exploring whether they act as shock absorbers or transmitters of risk to other financing markets[13]. These questions reflect the Bank’s recognition that private markets’ resilience depends not only on the quality of individual assets but also on the behavioral responses of market participants during stress periods, particularly regarding capital allocation decisions by institutional investors and financing decisions by banks that could either mitigate or amplify stress across the system[2][8]. The Bank has also acknowledged the importance of understanding how private markets’ closed-ended nature and long-term capital structure might influence their behavior during downturns, noting that “from a macroprudential perspective, the long-term nature of private market funding— including due to the closed-ended nature of many private market funds—allows and incentivises fund managers to act less cyclically, which can reduce the volatility of financing flows during macroeconomic downturns”[2][8]. This nuanced understanding of private markets’ structural characteristics represents a significant evolution in regulatory thinking, moving beyond simplistic comparisons with traditional banking to recognize the unique dynamics of non-bank financial intermediation.

Mapping the Private Markets Ecosystem: Size, Structure, and Interconnectedness

The rapid expansion of private markets over the past decade represents one of the most significant structural shifts in global finance, with total assets under management in private market funds reaching approximately $16 trillion globally, and within that, global private equity and private credit having expanded significantly from around $3 trillion to approximately $11 trillion over the past decade[8][23]. This extraordinary growth has transformed private markets from niche alternative investment vehicles into a mainstream source of corporate financing, with private equity-sponsored businesses now accounting for up to 15% of total UK corporate debt and 10% of private sector employment, representing more than two million jobs[2][8]. The evolution of private markets has been driven by multiple factors, including institutional investors’ search for yield in a low-interest-rate environment, regulatory changes that increased capital requirements for banks and reduced their willingness to lend to riskier borrowers, and the growing sophistication of private market participants in structuring complex financing solutions tailored to specific corporate needs[27][28]. Private equity has particularly benefited from large fundraising cycles, strong institutional allocations, and the tendency of companies to stay private longer, reducing public-market supply and creating opportunities for value creation through operational improvements and strategic repositioning[37]. The private credit market has similarly expanded, growing to approximately $1.5 trillion at the start of 2024 and estimated to soar to $2.6 trillion by 2029, driven by borrowers’ appreciation for the speed, certainty, and flexibility of private credit solutions amid tighter bank lending standards[27][30]. This growth trajectory reflects a fundamental shift in corporate financing, with private markets increasingly filling the gap left by retreating traditional banks, particularly in segments such as leveraged lending where regulatory constraints have made bank participation less attractive[28][30].

The structure of private markets has evolved significantly alongside their growth, with increasing specialization and diversification across strategies, sectors, and geographies creating a more complex ecosystem than the traditional buyout-focused private equity model of earlier decades[37][52]. While private equity and venture capital remain the largest and most visible engines of alternatives’ growth, the market has seen the emergence of specialized strategies including asset-based finance, opportunistic capital, unsponsored deals, growth companies requiring hybrid capital, and real estate lending, each with distinct risk-return profiles and operational characteristics[27][37]. The rise of private fund specialization has been driven by both supply-side factors, as asset managers seek to differentiate themselves in an increasingly competitive landscape, and demand-side factors, as institutional investors look for more targeted exposure to specific market segments or risk factors[37][59]. This specialization has led to the development of increasingly sophisticated investment vehicles, including continuation funds that allow general partners to extend their investment horizon in high-performing assets beyond the typical fund lifecycle, and CV-squared structures that represent continuation funds for assets already sitting in prior continuation vehicles[58][61]. These innovative structures, while providing flexibility and potentially enhancing returns, have also raised concerns about transparency, conflicts of interest, and the potential for extended holding periods to mask underlying performance issues[51][58]. The growth of private credit has similarly diversified beyond traditional leveraged lending to include investment-grade private placements, asset-based finance, and specialized strategies such as litigation finance and infrastructure debt, reflecting the sector’s maturation and broadening appeal to institutional investors seeking yield enhancement and diversification benefits[40][52].

Perhaps the most significant development in the private markets ecosystem has been the deepening interconnectedness between private markets and traditional banking, creating complex feedback loops that challenge traditional regulatory boundaries and raise questions about potential systemic risks[28][29]. Banks have increasingly expanded their strategic partnerships with private credit providers, moving beyond simple origination and distribution models to more integrated relationships that include joint ventures, referral models, and direct lending collaborations[30][43]. A Morgan Stanley and Oliver Wyman research report described how “the rise of private credit creates new opportunities for banks to generate revenues and returns by supporting the private credit industry,” noting that “banks continue to expand their partnerships with private credit providers” through activities such as providing first-lien financing for private transactions while sourcing the riskier second lien to private credit managers[28][30]. This evolution represents a fundamental shift in the corporate credit landscape, with banks increasingly acting as intermediaries between traditional depositors and private credit markets rather than direct lenders to corporate borrowers[28][43]. The Federal Reserve has documented this trend, noting that “banks currently hold about $79 billion in total revolving credit lines and about $16 billion in term loan exposures to the sector,” with about $49 billion for business development companies (BDCs) and $30 billion for private debt funds as of 2024-Q4[28][43]. This interconnectedness creates potential transmission channels for stress, as evidenced by the First Brands and Tricolor collapses, which exposed significant losses across a diverse range of financial market participants including banks, BDCs, CLOs, and broadly syndicated loan markets[3][22]. The Bank of England has specifically highlighted these interconnections as a key concern, noting in its Financial Stability Report that the Financial Policy Committee had “previously highlighted the interconnections with banks, insurers and leveraged finance markets, as well as potential vulnerabilities related to use of leverage, valuation challenges, and the extent of reliance on credit rating agencies”[8][45].

The growing importance of private markets within the broader financial ecosystem is further evidenced by their increasing role in financing critical sectors of the economy, particularly in areas where traditional bank lending has retreated due to regulatory constraints or risk considerations[27][30]. In the United States, private equity directly employed 13.3 million workers in 2024, with workers at private equity-backed businesses earning an average of $85,000 in wages and benefits, and the private equity sector contributing $2 trillion to gross domestic product, representing approximately 7% of total US GDP[53]. These figures underscore the significant economic footprint of private markets and explain why regulators are increasingly concerned about their potential impact on financial stability and the real economy[53][57]. The Bank of England’s recognition that “private equity and private credit play an increasingly valuable role in helping UK companies to innovate, invest and grow” reflects this broader understanding of private markets’ economic importance, while Deputy Governor for Financial Stability Sarah Breeden’s statement that “to keep delivering those benefits, we need a robust understanding of how risks might flow through the financial system in a stress” highlights the delicate balance regulators must strike between supporting

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