A screen is seen on the trading floor at the New York Stock Exchange (NYSE) in Manhattan, New York City, U.S.
Andrew Kelly | Reuters
A global finance watchdog is demanding national regulators better scrutinize private credit, warning that banks, asset managers, insurance and private equity firms are exposed to an assortment of growing risks in the near $2 trillion sector.
In a wide-ranging study published Wednesday, the Financial Stability Board said the industry’s lack of standardized, transparent data, along with opaque valuation practices and complex funding structures and vehicles, is bringing vulnerabilities to broader markets.
It comes amid growing jitters surrounding private credit in the U.S. — spanning software exposures, business development companies, and individual corporate blow-ups.
The FSB — which is made up of central bankers, regulators and finance ministers from the G20 countries — sounded the alarm on the sector’s increasing interconnectedness with banks, insurance companies and investment managers through bank credit lines, revolving facilities and strategic partnerships.
The FSB’s statistics showed $220 billion of drawn and undrawn credit lines from banks but commercial data suggested the amounts could be twice as large. While that’s a relatively small share of banks’ total CET1 capital, other linkages could heighten risks, the FSB said.
“This includes riskier fund portfolio financing, banks providing revolving credit facilities to companies that are simultaneously borrowing from private credit funds, and private credit-focused partnerships between banks and asset managers becoming more common.”
‘Deteriorating credit conditions’
The deep-dive report suggested that these links could amplify market stress, noting that the sector’s high leverage, which is concentrated in sectors like technology, healthcare and services, remains largely untested in a prolonged economic downturn.
“Some private credit borrowers also appear to be relying more on payment-in-kind loans, which can also signal deteriorating credit conditions,” the report added.
The FSB’s board wants national regulators to boost their supervision of the industry.
This includes sharing supervisory approaches on risk management and governance for banks and non-bank institutions in private credit, including aggregation of exposures, valuation and the use of private ratings, as well as tackling patchy loan-level data and strengthening scrutiny of liquidity mismatches.
Total private credit lending is sized roughly between $1.5 trillion and $2 trillion, with the market dominated by the U.S., followed by the euro zone area and the U.K., according to the FSB’s analysis.
The sector boomed in the years after the Global Financial Crisis in 2008, with private credit funds and other alternative investment vehicles stepping in to fill the lending gap created by the withdrawal of investment banks from riskier parts of the debt market.
Closer scrutiny
But while private credit in the past focused mainly on medium-sized companies, its investor base composed mainly of institutional investors, the market is now providing financing to larger firms, with retail investors increasingly onboard via semi-liquid, publicly-traded vehicles — the focus of recent redemption pressures in the U.S.
European banks’ exposure to private credit has also come under closer scrutiny during the current earnings season.
Barclays revealed $20 billion in private credit exposures, while Deutsche Bank‘s position is about $30 billion, which is about 2% of its total loan book. BNP Paribas, meanwhile, said it has a $25 billion private credit exposure, sized at roughly 3% of its loan book.
Both the European Central Bank and the Bank of England have expressed concern over potential systemic risks arising from private credit lately.
The Bank of England is conducting stress tests alongside the industry, with deputy governor Sarah Breeden last month highlighting concerns over asset quality, valuation discipline and liquidity.
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