Bailey warns global finance of double shock from valuations, leverage, credit

Andrew Bailey warned global finance that the system may have absorbed the immediate shock from the Middle East conflict, but that tighter funding conditions could still expose several weak points at once. In a letter published by the Financial Stability Board on April 13, the Bank of England governor said the danger was not a single market break but a chain reaction across stretched valuations, leverage in the non-bank sector and private credit.

Bailey, who also chairs the Financial Stability Board, flagged three areas for closer monitoring: government bond markets, global asset prices and private credit. The FSB said high leverage among a limited number of funds pursuing similar strategies across jurisdictions could trigger disorderly unwinding in government bond markets, where liquidity can disappear quickly when crowded trades move against investors. It also said global asset prices remained elevated by historical standards, with sectors linked to artificial intelligence especially vulnerable to sharp adjustment.

The strongest warning fell on private credit, where sentiment had already deteriorated before the conflict began. The FSB said the war could raise debt-servicing pressure on leveraged borrowers and reduce asset quality in private credit funds. It said it would shortly publish a report on those vulnerabilities and would work with the International Association of Insurance Supervisors on links between private equity, private credit and life insurance, a channel that has drawn more scrutiny as non-bank finance has expanded.

The warning landed against a wider backdrop of strained markets. The International Monetary Fund said in April that global financial stability risks were elevated, with the war in the Middle East, possible inflationary pressure and further tightening in financial conditions threatening to turn market turbulence into instability. The Fund said global equity prices had fallen 8 percent since February, while sovereign bond yields had risen sharply on expectations of higher inflation. Emerging-market assets were also being hit by a stronger dollar and rising energy prices.

Bailey’s message reflected a broader regulatory mood that the system is more resilient than in past crises, but not immune to simultaneous shocks. A European Parliament briefing ahead of his April 9 hearing noted that the financial sector had remained resilient despite the Middle East conflict and earlier blows from the pandemic, the 2021 inflation surge, Russia’s invasion of Ukraine and trade-tariff uncertainty. Even so, the briefing said new vulnerabilities had built up in private finance, sovereign debt and crypto markets.

Regulators are already moving on the concern. The Federal Reserve was asking major U.S. banks for details about their exposure to private credit after a rise in redemptions and troubled loans, a sign that scrutiny of the sector is intensifying. Bailey’s warning is an early stress test for a market structure built on more leverage, more non-bank lending and less room for error if shocks begin to compound.