Prem Sikka: The $63.2 trillion shadow banking industry is likely to be site of the next financial crash

Private equity is a key part of shadow banking and has been buying-up many businesses. What private equity entails is private equity firms using funds raised from institutional investors to acquire and engage in buyouts of businesses.


Prem Sikka is an Emeritus Professor of Accounting at the University of Essex and the University of Sheffield, a Labour member of the House of Lords, and Contributing Editor at Left Foot Forward.

The UK media headlines are dominated by a deepening cost-of-living crisis and a two-horse Conservative circus to be the next Prime Minister. Meanwhile, the finance industry is incubating the next economic crash.

Deregulation, shady practices and the chase for a quick buck were the main causes of the 2007-08 financial crash. The state provided £1,162bn of cash and guarantees to bail out the industry. Yet no real lessons have been learnt.

The $63.2 trillion shadow banking industry is likely to be site of the next financial crash. Private equity is a key part of shadow banking and has been buying-up many businesses. What private equity entails is private equity firms using funds raised from institutional investors to acquire and engage in buyouts of businesses. They gets their cash from insurance companies, pension funds, banks, local authorities, trusts and wealthy individuals.

The £895bn of quantitative easing has vastly increased the resources available to private equity.

Private equity firms function as banks but are not subjected to any minimum capital requirement, control on leverage or stress tests even though a collapse of a firm can destabilise the regulated sector. Recent collapse of the US-based Archegos Capital Management shows that domino effects spread very quickly and had negative effects on the capital buffers of Goldman Sachs, Morgan Stanley, UBS and Credit Suisse.

In 2021, 803 UK private equity buyout deals worth £46.8bn were completed. The investment is welcomed by many as it helped to save some jobs, but private equity also poses threats to jobs, pensions, the tax base and the wider economy.

On average, private equity retains its interest in a company for 5.9 years. There is no long-term commitment to any company, place, product, workers or community.

Financial engineering, high debt, tax avoidance and opacity are key tactics in extracting high short-term returns. A favourite tactic is to inject finance through secured debt i.e. private equity becomes a secured creditor. This means that in the event of bankruptcy private equity needs to be paid first. Unsecured creditors recover little, if anything, of the amounts due to them.

Bernard Matthews, Bonmarche, Cath Kidston, Comet, Debenhams, Flybe, HMV, Maplin, Monarch Airlines, Payless Shoes, Poundworld and Toys R Us are just some of victims of the predatory practices of private equity.

Pension schemes are looted. The demise of poultry company Bernard Mathews is a typical example. In September 2013, private equity acquired a £25m stake in Bernard Matthews. The company was loaded with a secured loan from its private equity controllers. In 2016, its assets were sold-off. Private equity made a profit of £13.9m. The key was dumping the amounts owed to unsecured creditors, including a £75m deficit on the employee pension scheme. 700 employees lost some of their pension rights.

Troubled mattress company Silentnight appointed KPMG as an administrator to enable its reconstruction. Instead, KPMG partners colluded with a private equity firm to sell the company cheaply by dumping its pension obligations. 1,200 employees lost some of their pension rights.

High street retailer Debenhams was hollowed-out by private equity. 12,000 jobs were lost, but its private equity controllers collected over £1 billion in dividends. Its pension scheme had a deficit of £32m and employees lost some of their pension rights.

During the 2006-2017 private equity ownership of Thames Water, debt ballooned from £2.4bn to £10bn, mostly from tax haven affiliates. Some £3.186bn was extracted as interest charges and another £1.2bn in dividends. It paid only £100,000 in corporation tax. The company routinely dumps raw sewage into rivers.

In 2020, private equity acquired Asda and it is now controlled from a specially created company is Jersey.  In 2021, rival supermarket Morrisons was also acquired by private equity and is now controlled from an entity in the Cayman Islands. The usual tactics of profit shifting and tax avoidance will follow.

Private equity has made inroads into care homes. One report stated that “care home groups have been stripped of their real estate, and were forced to rent them back (sale-lease-back)”. So, returns are increased by forcing care homes to pay rents. In addition, care homes are loaded with debts and interest charges extract around 16% of the care home fees. Dividends are high but staff wages are low leading to high staff turnover, making it difficult to provide personalised service to residents. Too many care homes fail to meet the basic standards of care.

The exploitative edifice of private equity is built on shaky grounds of debt, and what a leading asset manager described as “Ponzi and pyramid schemes”. Some private equity firms are falsely inflating their profits by selling businesses on to each other – and paying higher prices with little regard for actual value. Their solvency ratios may be illusory.

Alarm bells are ringing. The Bank for International Settlements states that rising interest rates will make it difficult for private equity and shadow banks to service their debts. A spate of corporate bankruptcies will follow. Almost every sector of the economy will be infected.

The recently published Financial Services and Markets Bill contains no plans to regulate shadow banking or private equity, and will actually roll-back many of the post 2007/08 crash reforms. All roads to financial crashes are paved with the obsession with deregulation. Have we learnt anything from history?

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