Britain’s shadow banking system is raising serious concerns after

LONDON — After last week’s chaos in British bond markets following the government’s Sep. 23 “mini-budget,” analysts are sounding the alarm on the country’s shadow banking sector.

The Bank of England was forced to intervene in the long-dated bond market after a steep sell-off of U.K. government bonds — known as “gilts” — threatened the country’s financial stability.

The panic was focused in particular on pension funds, which hold substantial amounts of gilts, while a sudden rise in interest rate expectations also caused chaos in the mortgage market.

While the central bank’s intervention offered some fragile stability to the British pound and bond markets, analysts have flagged lingering stability risks in the country’s shadow banking sector — financial institutions acting as lenders or intermediaries outside the traditional banking sector.

Former British Prime Minister Gordon Brown, whose administration introduced a rescue package for Britain’s banks during the 2008 financial crisis, told BBC Radio Wednesday that U.K. regulators would need to tighten their supervision of the shadow banks.

“I do fear that as inflation hits and interest rates rise, there will be a number of companies, a number of organizations that will be in grave difficulty, so I don’t think this crisis is over because the pension funds have been rescued last week,” Brown said.

“I do think there’s got to be eternal vigilance about what has happened to what is called the shadow banking sector, and I do fear that there could be further crises to come.”

Global markets took heart in recent sessions from weakening economic data, which is seen as reducing the likelihood that central banks will be forced to tighten monetary policy more aggressively in order to rein in sky-high inflation.

Edmund Harriss, chief investment officer at Guinness Global Investors, told CNBC Wednesday that while inflation will be tempered by the decline in demand and impact of higher interest rates on household incomes and spending power, the danger is a “grinding and extension of weakening demand.”

The U.S. Federal Reserve has reiterated that it will continue raising interest rates until inflation is under control, and Harriss suggested that month-on-month inflation prints of more than 0.2% will be viewed negatively by the central bank, driving more aggressive monetary policy tightening.

Harriss suggested that sudden, unexpected changes to rates where leverage has built up in “darker corners of the market” during the previous period of ultra-low rates could expose areas of “fundamental instability.”

“When going back to the pension funds issue in the U.K., it was the requirement of pension funds to meet long-term liabilities through their holdings of gilts, to get the cash flows coming through, but ultra-low rates meant they weren’t…