Buyout Debt Could Risk Financial Stability, Bank of England Says

High-risk loans used to finance buyouts before the credit crisis may pose a “significant risk” to the U.K.’s financial system, according to the Bank of England, which next month takes over responsibility for protecting the country’s banking sector.

Leveraged loans arranged by private-equity companies before the crisis have “implications for the fragility of the corporate sector and, consequently, the resilience of the financial system,” Bank of England analysts led by David Gregory wrote in a report. Losses at Royal Bank of Scotland Group Plc, which was rescued by the U.K. government, followed its expansion into leveraged finance, it said.

Private-equity owned companies account for about 8 percent of U.K. corporate sector debt, according to the report. About 34 billion pounds ($50 billion) of U.K. leveraged loans mature in 2013 and 2014, according to data compiled by Bloomberg.

European banks are under pressure from regulators to reduce their exposure to risky assets such as leveraged loans making it more difficult for some private-equity owned companies to refinance debt. Better-rated companies have been able to replace loans with junk bonds, boosted by record-low yields for the high-yield notes.

Private-equity companies could play a role in the U.K.’s economic recovery by restructuring companies in difficulty, according to the report. “By taking over struggling companies and restructuring them, private equity might be able to play a part in increasing the productivity of the U.K. corporate sector,” it said.

The Financial Services Authority will be replaced on April 1 by the Prudential Regulation Authority, which will become a unit of the Bank of England, keeping watch on systemic financial issues. The Financial Conduct Authority will have an increased focus on protecting British consumers.

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