A screen is seen on the trading floor of the New York Stock Exchange (NYSE) in Manhattan, New York City, United States
Andrew Kelly | Reuters
A global financial watchdog is demanding that national regulators take greater scrutiny of private credit, warning that banks, asset managers, insurance and private equity firms are exposed to a growing set of risks in a nearly $2 trillion sector.
In a wide-ranging study released Wednesday, the Financial Stability Board said a lack of standardized and transparent industry data, as well as opaque valuation practices and complex financing structures and vehicles, are undermining broader markets.
This comes amid growing nervousness around private credit in the United States – which spans software exposures, business development companiesand individual businesses explosions.
The FSB – made up of central bankers, regulators and finance ministers from G20 countries – sounded the alarm about the sector’s growing interconnectedness with banks, insurance companies and investment managers through bank credit lines, revolving facilities and strategic partnerships.
FSB statistics show $220 billion in drawn and undrawn credit lines with banks, but trade data suggests the amounts could be twice as large. Although this represents a relatively small share of banks’ total CET1 capital, other links could increase risks, the FSB said.
“This includes riskier fund portfolio financing, banks providing revolving credit facilities to companies that simultaneously borrow from private credit funds, and private credit-focused partnerships between banks and asset managers becoming increasingly common.”
“Deterioration of credit conditions”The in-depth report suggests these ties could amplify market tensions, noting that the sector’s high leverage, concentrated in sectors such as technology, healthcare and services, remains largely untested in a prolonged economic downturn.
“Some private borrowers also appear to rely more on in-kind loans, which may also signal deteriorating credit conditions,” the report adds.
The FSB board wants national regulators to strengthen their oversight of the sector.
This involves sharing prudential approaches to risk management and governance for banks and non-bank institutions in private credit, including exposure aggregation, valuation and the use of private ratings, as well as addressing patchy loan-level data and strengthening monitoring of liquidity mismatches.
Total private loans are between $1.5 trillion and $2 trillion, with the market dominated by the United States, followed by the Eurozone and the United Kingdom, according to the FSB analysis.
The sector boomed in the years following the 2008 global financial crisis, with private credit funds and other alternative investment vehicles stepping in to fill the lending gap created by investment banks’ withdrawal from the riskier segments of the debt market.
A Closer LookBut while in the past private credit focused primarily on mid-sized companies, with its investor base primarily made up of institutional investors, the market now provides financing to larger companies, with retail investors increasingly involved through publicly traded semi-liquid vehicles – the focus of recent takeover pressures in the United States.
Exposure of European banks to private credit has also come under greater scrutiny during the current earnings season.
Barclays revealed $20 billion in private credit exposures, while German BankThe company’s position is approximately $30 billion, or about 2% of its total loan portfolio. BNP Paribasmeanwhile, said it has $25 billion in private credit exposure, valued at about 3% of its loan portfolio.
The European Central Bank and the Bank of England have recently expressed concern about potential systemic risks arising from private credit.
Bank of England conducts stress tests alongside sector, with deputy governor Sarah Breeden last month highlighting concerns about asset quality, valuation discipline and liquidity.
