Financial Stability Board sounds alarm on private credit stress
A screen is seen on the trading floor of the New York Stock Exchange (NYSE) in Manhattan, New York City, USA
Andrew Kelly | Reuters
A global finance watchdog is demanding national regulators better scrutinize private lending, warning that banks, asset managers, insurance and private equity firms are increasingly exposed to a range of risks in the nearly $2 trillion industry.
In a wide-ranging study published on Wednesday, the Financial Stability Board said the industry’s lack of standardized, transparent data, as well as opaque valuation practices and complex funding structures and instruments, pose vulnerabilities to broader markets.
This development comes at a time of tensions in the United States, including rising software risks related to private loans, business development companies and individual corporate implosion.
The FSB, made up of central bankers, regulators and finance ministers from G20 countries, has raised alarm over 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 in undrawn lines of credit from banks, but trading data suggested these amounts could be twice as large. The FSB said that although this was a relatively small share of the banks’ total CET1 capital, other connections could increase risks.
“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 more common.”
‘Credit conditions are getting worse’
The in-depth report suggested that these linkages could increase market stress, noting that the sector’s high leverage, concentrated in sectors such as technology, healthcare and services, remained largely untested in a protracted economic crisis.
“Some private loan borrowers also appear to be relying more on pay-in-kind loans, which could signal worsening credit conditions,” the report said.
The FSB board wants national regulators to increase their oversight of the sector.
This includes sharing supervisory approaches to risk management and governance for banks and non-banks in private lending, including risk aggregation, valuation and use of specific ratings, as well as addressing irregular loan level data and strengthening the review of liquidity mismatches.
According to the FSB’s analysis, the size of total private credit loans is roughly between $1.5 trillion and $2 trillion, with the US dominating the market, followed by the eurozone region and the UK.
The sector experienced massive growth in the years after the 2008 Global Financial Crisis, as private credit funds and other alternative investment vehicles stepped in to fill the credit gap created by investment banks withdrawing from risky parts of the debt market.
Closer inspection
But while in the past private credit focused mainly on mid-sized companies and the investor base consisted mostly of institutional investors, the market now provides financing to larger firms and individual investors are increasingly participating through semi-liquid, publicly traded vehicles; which is the focus of recent redemption pressures in the US.
Barclays It exposed $20 billion of private credit risk. German Bank‘s position is approximately $30 billion, or approximately 2% of the total loan book. BNP ParibasMeanwhile, it said it has $25 billion of private credit exposure, roughly 3% of its loan book.
Both the European Central Bank and the Bank of England have recently expressed concerns about potential systemic risks from private lending.
Bank of England conducts stress tests with industry, with deputy governor Sarah Breeden highlights from last month concerns regarding asset quality, valuation discipline and liquidity.
