Positive Money – Written evidence (PMG0015)

Positive Money welcomes the opportunity to respond to the Committee’s inquiry into the growth of private markets in the UK following reforms introduced after 2008.

We are a not-for-profit civil society organisation, working towards reform of the money and banking system to support a fair, democratic and sustainable economy. We are funded by charitable trusts, foundations and small donations.

Our submission makes the following key points:

●       The proportion of UK bank lending to the real economy has continued to fall since 2008. This is a trend that can be traced much further back, to developments such as the deregulation of the mortgage market and the abandonment of effective credit policies since the 1970s. However it is plausible that post-crisis regulatory reforms exacerbate structural biases against real economy lending, and activity may have shifted to non-banks.

●       There is a risk that the growth of private markets further exacerbates the financial system’s inability to meet the needs of the real economy, particularly given that SMEs have typically relied on bank credit for external financing, and are less able to access market-based finance.

●       The growth of market-based finance likely reflects the shifting of risk from more regulated banks to less regulated shadow banks, rather than the disappearance of risk. This could mean the reduction of systemic risk in the banking system, but a greater threat of systemic market risk, as illustrated by more pronounced gilt price volatility in recent years.

●       We expect market-based finance to continue to grow if regulatory arbitrage becomes increasingly attractive as policymakers seek to make regulatory regimes more ‘competitive’ for non-bank financial institutions while maintaining more costly regulation of banks via Basel 3.1. New forms of money outcompeting bank deposits as a means of payments may also amplify such disintermediation.

●       Regulatory arbitrage could be avoided by introducing stronger and simpler regulation that treats any issuer of short-term money-like liabilities, whether banks or non-banks, equally. Former Bank of England policymakers such as Lord King and Sir Paul Tucker have put forward compelling collateral-based regulatory proposals to this end.

1. Has bank lending to the real economy in the UK reduced as a proportion of the total volume of finance provided annually since 2008? If so, to what extent can this change be attributed to the reforms to the UK’s regulation of bank capital and liquidity requirements? To what extent has any reduction led to an increase in finance by private markets?

1.1.            Bank lending to the real economy has declined significantly as banks have shifted focus from business lending to lending against mortgages. Lending against mortgages made up 39.7% of total bank lending in the last month of 2008, but as of June 2025 this figure had risen to 54% of total bank lending.[1] The proportion of total lending going towards businesses operating in the real economy (excluding finance, insurance, and the real estate industries) has fallen from 11.6% in July 2009 to 9.6% as of June 2025. In the same time period, the ratio of lending to the real economy relative to mortgage lending fell drastically from 0.28 to 0.17, showing the continued neglect of productive lending while increasingly favouring lending towards the purchasing of already existing assets, particularly property.

1.2.            These trends predate the increase in bank capital and liquidity requirements as a result of Basel, and have instead been driven by the deregulation of the mortgage market and the decline of credit guidance since the 1970s. For example, analysis of bank lending shows that the proportion of total lending against mortgages was only 16.4% in Q4 1986, but had risen to 31.6% by Q4 1996 and 40.1% by Q4 2006. In contrast, a minimum of 36% of total lending in 1986 was held by businesses in the real economy, but this figure has steadily declined since then and was at 9.6% as of June 2025.[2]

1.3.            However it is plausible that Basel capital and liquidity requirements have exacerbated banks’ neglect of the real economy. Under Basel’s capital adequacy ratios, lending against property typically offers the best return on equity for banks, so it is unsurprising that the UK’s banking sector, which is dominated by a handful of large publicly-listed lenders compelled to maximise shareholder value, has prioritised mortgage lending. Likewise, real economy is not typically considered high-quality liquid assets (HQLA) and is thus disfavoured by the Liquidity Coverage Ratio compared to purchases of existing assets.

1.4.            SMEs are the backbone of the real economy, but despite employing 60% of private sector workers, they have received only 2-5% of bank credit in recent years.[3] This is particularly concerning given that SMEs have typically relied on banks for external financing, and very few are in a position to issue their own marketable securities in the form of bonds or equities, and are therefore unlikely to benefit from the growth of market-based finance.

2. What interconnections exist between the UK’s banking sector and private markets? How have these interconnections changed since 2008, and how do you expect them to continue to develop?

2.1.            The banking sector and private markets are intertwined. Banks rely on markets for wholesale funding, and also play a significant role in providing liquidity to private markets. This is reflected in the scale of intrafinancial sector lending, which has emerged as the second largest type of bank lending behind mortgages. Credit to the financial sector and non-financial remained at roughly equal levels in the decade up to 2007, yet in the years since, the financial services industry has consistently held a much higher stock of loans than the combined amount held by all industries in the real economy, standing at £470bn and £249bn, respectively, as of June 2025.

2.2.            We may expect bank reliance on wholesale funding to increase, especially if ‘disintermediation’ is accelerated as new forms of money, such as stablecoins or central bank digital currencies, outcompete bank deposits as a means of payment.

3. What are the implications of the growth in private markets, and interconnections with the wider financial services sector, for lending to the real economy and the UK’s financial stability?

3.1.            As the Bank of England notes, private equity has grown significantly in recent years, with global assets under management growing from around $2tn in 2012 to around $8tn in 2023.[4] It is questionable whether this has resulted in greater efficiency in financial services, let alone better outcomes for the real economy. As former Chairman of the Financial Services Authority Lord Turner has observed, “large increases in assets under management as a percentage of GDP have not been matched by economy of scale effects - cost per unit of output falling as volumes rise - which are observed in most other sectors of the economy.”[5]

3.2.            The growth of market-based finance means that credit creation and financial stability is more vulnerable to financial markets. The Bank of England has therefore had to go beyond its role as lender of last resort to the banking system to act as market-maker of last resort. The Bank of England is thus extending its liquidity umbrella increasingly widely. The absence of real democratic scrutiny of who the Bank of England provides liquidity to, on what terms and for what purpose, is concerning. The public is effectively underwriting an ever-larger share of the financial system, with little consideration of how this can benefit the real economy.

3.3.            Given the well-researched evidence that an outsized financial sector is an obstacle to growth in the real economy and improvements in productivity,[6] it is deeply concerning that the financial services industry consistently holds close to two times the amount of credit held by companies in the real economy. An analysis of bank lending data suggests that the UK is already experiencing the crowding out scenario, as the stock of loans held in mortgages has increased by £390bn since 2009 while the stock of loans held by companies in the real economy has only increased by £10bn during the same time.

3.4.            The fact that only 9.6% of all outstanding credit is held in the real economy is a concern from the perspective of financial stability. A prolonged and systemic favouring of lending towards speculative activities increases the risk of a financial crisis by driving up the prices of assets, which can only be sustained for so long without an equivalent increase in real economic output.

3.5.            As noted in 1.4, SMEs have typically relied on bank credit for external financing as, unlike larger corporations, they are less able to raise funds by issuing marketable securities. There is therefore a risk that a shift to market-based finance further harms SMEs, which are the backbone of the real economy.

3.6.            The growth of market-based finance may reflect regulatory arbitrage, with risk shifting from the banking system to non-banks rather than disappearing. The Bank of England’s Financial Stability Reports have identified increasing vulnerabilities in market-based finance, which could have implications for financial stability.[7] There are growing risks from market participants increasing leveraged trading, which amplifies asset price volatility, as famously demonstrated by the 2022 LDI crisis and the ‘dash for cash’ in Spring 2020. The increased participation of a concentrated hedge fund sector in gilt markets with leveraged positions may be particularly concerning for market volatility and financial stability.

4. How transparent are the valuations, price discovery mechanisms, and structure of ownership of assets adopted by private markets? Does the Bank of England have sufficient visibility in non-bank finance, and what changes, if any, should be made to address this?

4.1.            Shadow banking is by its nature more opaque and the Bank of England has less visibility compared to the banking sector, which it supervises more closely. However the Bank of England appears to have made efforts to increase monitoring of market-based finance, as reflected in its Financial Stability Reports, which is welcome.

4.2.            More worryingly, policymakers’ fixation with deregulation has further reduced transparency towards market participants. For example, the government has inexplicably weakened short-selling regulation, removing requirements for investors to report short positions for sovereign debt, including gilts. This should be particularly concerning given the growing importance of leveraged hedge funds in gilt markets.

4.3.            As discussed below, a greater role for pre-positioning of collateral would facilitate greater central bank supervision of non-bank finance.

5. Are there systemic risks that the Bank of England should be aware of regarding non-bank financial intermediation? If so, how can these risks be mitigated?

5.1.            Former Bank of England deputy governor Sir Paul Tucker has repeatedly raised the alarm on systemic risks from NBFIs,[8] but it is unclear whether sufficient action has yet been taken by central banks. Policymakers appeared to have been inattentive to the buildup of pension fund leverage which culminated in the LDI crisis in September 2022.[9] As Tucker suggests, risks could be mitigated by requiring both banks and shadow banks to pre-position sufficient collateral to cover 100 per cent of short-term liabilities. Former Bank of England governor Lord King’s proposal for central banks to act as ‘Pawnbroker for All Seasons’ echoes such proposals.[10] This would be a more efficient way of managing risk while also eliminating regulatory arbitrage, and as explored in 9.2, may also increase the ability of the financial system to support the real economy.

6. How has demand for finance from businesses changed since 2008, and how do you expect this will develop?

6.1.            Demand for finance from businesses was weak in the years following the 2008 crisis as businesses (as well as households) were overleveraged with existing debts. There may have been a deleveraging in more recent years, but businesses’ demand for financing is primarily driven by demand from customers, which is in turn driven by investment. Given that currently tight monetary conditions constrains demand for investment, and that the government is intent on fiscal contraction, it is unlikely that aggregate demand, and thus demand for finance from businesses, will strengthen, continuing the UK’s doom loop of low investment and stagnation favoured by HM Treasury.

7. How has the regulation of bank capital and liquidity requirements affected the ability and willingness of banks to provide lending to the real economy? Are there disincentives in regulation that inhibit businesses’ ability and willingness to access finance through banks?

7.1.            As noted in 1.3, given that the UK’s banking sector is dominated by banks that are compelled to maximise shareholder value, capital and liquidity requirements currently disincentivise maturity transformation in the service of real capital formation. Under Basel capital requirements, lending against existing assets, such as mortgages, typically offers a greater return on equity than the financing of new capital stock, especially in the short-run. Liquidity requirements, such as the liquidity coverage ratio, reduce banks’ ability or willingness to use deposit funding to provide finance to the real economy, particularly the longer-term capital investment required.

8. To what extent do private markets have a competitive advantage over the banking sector to provide finance to businesses; if so, why? To what extent are any competitive advantages regulatory in nature?

8.1.            Banks benefit from considerable subsidies in the form of deposit insurance, TBTF and direct access to central bank liquidity, which greatly reduce their cost of borrowing. However, as discussed above, commercial banks face more stringent capital and liquidity requirements reflecting the fact that they are relied on to provide a safe and sound medium of exchange, with bank deposits being the most widely used form of money in the modern economy. This means that non-bank intermediaries may be able to benefit from regulatory arbitrage in financing that is disfavoured by banking rules, including business investment. Banks’ subsidies are instead used to support unproductive credit creation for the purchase of existing assets, such as property.

8.2.            The ability of private markets to finance long-term productive capital development may however also be hindered by liquidity constraints, as non-bank financial intermediaries, particularly those reliant on rolling over short-term funding, are vulnerable to daily changes in collateral valuations. Greater pre-positioning of collateral to access central bank liquidity at pre-agreed haircuts may help overcome this.

9. What, if any, reforms to bank capital regulation could be implemented to increase the risk appetite of the banking sector to provide lending to the real economy?

9.1.            Reform of bank capital regulation could increase lending to the real economy, particularly if capital requirements are adjusted to remove biases towards lending against property. However reform of capital requirements is limited by the Basel framework, and other macroprudential tools could be better utilised for this purpose.[11]

9.2.            A ‘Pawnbroker for all Seasons’ approach, as discussed in 5.1, is a fruitful path for regulatory reform. With such pre-positioning in place, the risk-weighted capital adequacy ratio could be replaced with a simple leverage ratio, and as such capital requirements wouldn’t discriminate against particular types of lending. Haircuts could be lowered for real economy lending that generates income to repay debts and raised for speculative positions in assets that instead rely on capital gains. This would be consistent with Hyman Minsky’s prescription that the central bank should use its discount window to encourage hedge financing structures and lean against speculative and ponzi financing.

18 September 2025

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