The UK's banking regulator is examining whether Barclays used accounting treatment that made certain private-credit-linked derivatives appear easier to trade than they really are, a practice that could lower the amount of capital the bank is required to hold.
The Prudential Regulation Authority (PRA) is reviewing a complaint that traders at Barclays booked total return swaps tied to illiquid loans as trading positions rather than as held-to-maturity or other categories. Total return swaps are contracts in which one party receives the total economic performance of an underlying asset—including income and any price changes—while the other party pays a fee. When such swaps are classified as trading positions, banks can often apply lower capital charges than if they were classified as held-to-maturity or available-for-sale.
Why the classification matters
Banks are required to hold capital as a cushion against unexpected losses. The amount of capital depends on the riskiness of their assets. Illiquid loans, such as those in private credit, are generally considered riskier because they cannot be easily sold in a downturn. If a bank labels a derivative tied to such loans as a trading position, it may be able to argue that the position is actively managed and therefore subject to lower capital requirements.
However, if the underlying loans are not truly liquid, the trading label may be misleading. The PRA's review suggests that Barclays may have understated the risk and capital needs associated with these positions. The complaint was filed by an unnamed party, and the PRA has not yet made any findings.
Barclays has not commented publicly on the matter. The bank has previously stated that it follows all applicable accounting and regulatory rules.
Private credit's rapid growth
Private credit—lending by non-bank funds to companies that cannot easily access public markets—has grown rapidly in recent years. This asset class now manages over $1.5 trillion globally, according to industry estimates. Banks are increasingly involved in private credit, either as direct lenders or through derivatives that give them exposure to the loans without holding them on their balance sheets.
The private credit market's cash pile has been outpacing its deal flow, which means funds have more money to deploy than there are attractive lending opportunities. This has led to increased competition and potentially looser terms, raising concerns among regulators about the riskiness of the sector.
Regulatory scrutiny intensifies
The PRA's review is part of a broader regulatory push to understand and manage the risks posed by private credit. Central banks and regulators worldwide have warned about the potential for hidden leverage and liquidity mismatches in the sector. The Bank of England has previously said it is monitoring the growth of private credit and its interactions with the banking system.
This is not the first time Barclays has faced regulatory scrutiny over its accounting practices. In 2022, the bank was fined by the PRA for failures in its risk management systems. More recently, the bank has been working to improve its controls and compliance.
The outcome of the PRA's review could have implications for how all banks account for private-credit-linked derivatives. If the regulator determines that Barclays misclassified these positions, it could require the bank to hold more capital, which would reduce its profitability. It could also lead to changes in industry-wide accounting standards.
What it means for investors
For everyday investors, this news is a reminder that banks' reported capital ratios may not always reflect the true riskiness of their assets. If a bank is understating risk, it could be more vulnerable to losses than its financial statements suggest.
Investors should watch for any updates from the PRA or Barclays. If the regulator requires Barclays to hold more capital, it could affect the bank's dividend or share buyback plans. It could also signal that other banks with similar exposures may face similar scrutiny.
For those invested in private credit funds, the news highlights the importance of understanding how these funds use derivatives and leverage. The rising cost of insuring debt in credit markets is another sign that investors are becoming more cautious about credit risk.
The PRA's review is ongoing, and no conclusions have been reached. Barclays has said it cooperates fully with its regulators. The bank's shares have not moved significantly on the news, suggesting that investors are waiting for more details.
In the meantime, the broader banking sector is also dealing with other regulatory issues, such as the Swiss court ruling on bonus clawbacks at Credit Suisse, which could have implications for executive pay practices across the industry.
For now, the key takeaway is that regulators are paying close attention to how banks account for complex derivatives tied to illiquid assets. This is a developing story, and investors should stay informed.
