The Bank of England’s decision to accept a wider range of private and structured credit assets as collateral in its lending operations is raising questions over how readily those securities can be traded outside the central bank, as tighter credit conditions and mounting losses put pressure on the rapidly expanding private credit market.
“It is possible that the non-BoE market for these assets might not be as active as it was because there’s a lower appetite for credit in private markets,” said Moyeen Islam, a fixed-income analyst at Barclays.
The issue highlights a potential tension in the Bank of England’s collateral framework: assets that are acceptable for central-bank funding may not necessarily have deep or reliable secondary markets when investors become more risk-averse.
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The global private credit industry, now worth about $3.5 trillion, has expanded rapidly over the past several years as investors have sought higher yields than those available in traditional fixed-income markets. The sector has increasingly financed borrowers that may have limited access to conventional bank lending.
That growth, however, has brought greater scrutiny from regulators and investors, particularly as a series of negative headlines, valuation concerns and high-profile losses have raised questions about credit quality and the ability of private-market lenders to absorb a downturn.
Riskier Assets Enter The Collateral Pool
The Bank of England’s Level C collateral list includes securities linked to a range of consumer, vehicle and small-business loans, some of which carry higher levels of credit or residual-value risk.
Among them are loan notes issued by Temese Funding, linked to Investec, which S&P Global says are backed by heavy-equipment and vehicle leases. The leases feature large final instalments, commonly known as balloon payments, which can leave lenders exposed to the value of the underlying assets when borrowers reach the end of their contracts.
The treatment of such assets is becoming an increasingly important issue across Europe.
The European Central Bank effectively removed similar products from its eligible collateral pool in January following a change in its approach to residual-value risk, according to an analysis by law firm Jones Day.
The contrast between the ECB and Bank of England approaches illustrates the difficulty central banks face in determining which private-market assets can provide dependable liquidity during periods of market stress. The BoE does not disclose which individual securities on its Level C list have actually been pledged as collateral in its Indexed Long-Term Repo operation, or ILTR.
Mortgage-Backed Assets Also Face Scrutiny
The list also includes securities issued by Harben Finance, which public filings show is controlled by Barclays. The company owns payment streams from buy-to-let mortgages originated by former UK lender Bradford & Bingley before the bank was rescued by the UK government during the 2008 financial crisis.
Some tranches of Harben Finance debt have experienced multiple rating downgrades over the past year, with Fitch Ratings downgrading some securities twice and S&P Global lowering its rating once.
The presence of such assets on the BoE’s collateral list does not necessarily mean the central bank considers them high-risk or expects losses. Rather, eligibility allows financial institutions to use qualifying securities to obtain central-bank liquidity subject to the Bank’s collateral and risk-management framework.
The distinction is nevertheless important because collateral eligibility can provide liquidity to assets that might become difficult to finance privately during periods of market stress.
Other securities eligible for the BoE’s lending operations include loan notes backed by credit-card receivables from NewDay, the KKR-backed consumer finance company.
Fitch has said the underlying credit-card portfolio was aimed at higher-risk borrowers, adding another layer of consumer-credit exposure to the pool of securities eligible for central-bank financing.
The BoE list also includes debt issued in 2024 by the Small Business Origination Loan Trust, which packages repayments from business owners who obtained financing through Funding Circle’s lending platform.
S&P Global said in an August 21 note that almost one-fifth of the loans in that Funding Circle pool were likely to default. Funding Circle declined to comment.
The potential default rate matters because small businesses are generally more vulnerable to higher borrowing costs, weaker consumer demand and deteriorating cash flows than larger companies with greater access to diversified sources of funding.
Why The Collateral Issue Matters
The developments point to a broader question confronting central banks as private credit becomes an increasingly important part of the financial system: how liquid are these assets when liquidity is most needed?
Traditional government bonds and highly traded corporate securities generally have established markets and transparent pricing. Private credit and securitized loan assets can be harder to value and trade, particularly when investors simultaneously seek to reduce risk.
That situation becomes crucial during periods of financial stress. If private-market demand weakens, borrowers and lenders may find it harder to sell or refinance assets without accepting substantially lower prices. Central-bank collateral operations can provide an alternative source of liquidity, but they do not eliminate the underlying credit risk.
For the Bank of England, the challenge is therefore not simply determining whether an asset is eligible as collateral. It is ensuring that the valuation, haircuts and other safeguards adequately protect the central bank if market liquidity deteriorates and defaults rise.
The issue also has implications beyond the UK. The $3.5 trillion private credit market has become increasingly interconnected with banks, insurers, asset managers and securitization markets. A deterioration in private-credit portfolios could therefore transmit losses beyond the funds and lenders that originated the loans.
While the BoE’s framework provides an important liquidity backstop for eligible assets for now, the widening scrutiny of the collateral pool suggests that investors are becoming more focused on a critical distinction: an asset can be acceptable to a central bank for funding purposes without necessarily being easy to sell in the market when confidence disappears.