Private credit is now so big globally that the International Monetary Fund has dedicated an entire chapter in its latest Global Financial Stability Report to its “rise and risks.” In the report released last week, IMF said the private credit market, in which specialised non-bank financial institutions such as investment funds lend to corporate borrowers, topped $2.1 trillion last year in assets and committed capital. Many others such as JPMorgan has argued that the IMF may be under-estimating the true size of the industry and pegs it at well over $3 trillion. About three-quarters of this was in the US, where its market share is nearing that of syndicated loans and high-yield bonds. In the past few years, the private credit market has grown rapidly and institutional investors have eagerly invested in funds that, though illiquid, offered higher returns and less volatility.
Though India is still a relatively small market for private credit, there are important pointers in the report that our policymakers and regulators should take note of. There is no doubt that private credit has created significant economic benefits by providing long-term financing to corporate borrowers. However, the migration of this lending from regulated banks and more transparent public markets to the more opaque world of private credit creates potential risks. Today, immediate financial stability risks from private credit appear to be limited, IMF says. However, given that this ecosystem is opaque and highly interconnected, and if fast growth continues with limited oversight, existing vulnerabilities could become a systemic risk for the broader financial system.
The report has identified a number of other fragilities, too. First, companies that tap this market tend to be smaller and carry more debt than their counterparts with leveraged loans or public bonds. This makes them more vulnerable to rising rates and economic downturns. With the recent rise in benchmark interest rates, more than one-third of borrowers now have interest costs exceeding their current earnings. Second, while private credit fund leverage appears to be low, the potential for multiple layers of hidden leverage within the private credit ecosystem does raise concerns given the lack of data. Leverage is deployed also by investors in these funds and by the borrowers themselves. This layering of leverage makes it difficult to assess potential systemic vulnerabilities of this market.
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In comparison to the global numbers, the Indian private credit market is quite small to pose any large, systemic risk. But that’s not the point. The market is growing fast — an industry study estimated that assets managed by alternate investment funds (AIFs) are likely to soar to $60-70 billion by 2028—and it’s good that regulators in India have been closely watching developments and have from time-to-time issued regulations to stop the abuse of private credit structures. Examples are the Securities and Exchange Board of India’s restriction on senior-junior structures for AIFs and the recent Reserve Bank of India circular on restricting regulated entities from investing in funds which make investments in debtor companies of regulated entities. These were required as it is well-known that AIF structures have been abused. But while stepping up the vigil, care needs to be taken that over-regulation does not end up stifling the private credit market, which solves the very real problem of making available credit for certain bona fide purposes and entities, which may not be able to obtain such credit from regular financing channels. So, make haste slowly.
Private credit is now so big globally that the International Monetary Fund has dedicated an entire chapter in its latest Global Financial Stability Report to its “rise and risks.” In the report released last week, IMF said the private credit market, in which specialised non-bank financial institutions such as investment funds lend to corporate borrowers, topped $2.1 trillion last year in assets and committed capital. Many others such as JPMorgan has argued that the IMF may be under-estimating the true size of the industry and pegs it at well over $3 trillion. About three-quarters of this was in the US, where its market share is nearing that of syndicated loans and high-yield bonds. In the past few years, the private credit market has grown rapidly and institutional investors have eagerly invested in funds that, though illiquid, offered higher returns and less volatility.
Though India is still a relatively small market for private credit, there are important pointers in the report that our policymakers and regulators should take note of. There is no doubt that private credit has created significant economic benefits by providing long-term financing to corporate borrowers. However, the migration of this lending from regulated banks and more transparent public markets to the more opaque world of private credit creates potential risks. Today, immediate financial stability risks from private credit appear to be limited, IMF says. However, given that this ecosystem is opaque and highly interconnected, and if fast growth continues with limited oversight, existing vulnerabilities could become a systemic risk for the broader financial system.
The report has identified a number of other fragilities, too. First, companies that tap this market tend to be smaller and carry more debt than their counterparts with leveraged loans or public bonds. This makes them more vulnerable to rising rates and economic downturns. With the recent rise in benchmark interest rates, more than one-third of borrowers now have interest costs exceeding their current earnings. Second, while private credit fund leverage appears to be low, the potential for multiple layers of hidden leverage within the private credit ecosystem does raise concerns given the lack of data. Leverage is deployed also by investors in these funds and by the borrowers themselves. This layering of leverage makes it difficult to assess potential systemic vulnerabilities of this market.
In comparison to the global numbers, the Indian private credit market is quite small to pose any large, systemic risk. But that’s not the point. The market is growing fast — an industry study estimated that assets managed by alternate investment funds (AIFs) are likely to soar to $60-70 billion by 2028—and it’s good that regulators in India have been closely watching developments and have from time-to-time issued regulations to stop the abuse of private credit structures. Examples are the Securities and Exchange Board of India’s restriction on senior-junior structures for AIFs and the recent Reserve Bank of India circular on restricting regulated entities from investing in funds which make investments in debtor companies of regulated entities. These were required as it is well-known that AIF structures have been abused. But while stepping up the vigil, care needs to be taken that over-regulation does not end up stifling the private credit market, which solves the very real problem of making available credit for certain bona fide purposes and entities, which may not be able to obtain such credit from regular financing channels. So, make haste slowly.
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Regulating private credit
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20.04.2024
Private credit is now so big globally that the International Monetary Fund has dedicated an entire chapter in its latest Global Financial Stability Report to its “rise and risks.” In the report released last week, IMF said the private credit market, in which specialised non-bank financial institutions such as investment funds lend to corporate borrowers, topped $2.1 trillion last year in assets and committed capital. Many others such as JPMorgan has argued that the IMF may be under-estimating the true size of the industry and pegs it at well over $3 trillion. About three-quarters of this was in the US, where its market share is nearing that of syndicated loans and high-yield bonds. In the past few years, the private credit market has grown rapidly and institutional investors have eagerly invested in funds that, though illiquid, offered higher returns and less volatility.
Though India is still a relatively small market for private credit, there are important pointers in the report that our policymakers and regulators should take note of. There is no doubt that private credit has created significant economic benefits by providing long-term financing to corporate borrowers. However, the migration of this lending from regulated banks and more transparent public markets to the more opaque world of private credit creates potential risks. Today, immediate financial stability risks from private credit appear to be limited, IMF says. However, given that this ecosystem is opaque and highly interconnected, and if fast growth continues with limited oversight, existing vulnerabilities could become a systemic risk for the broader financial system.
The report has identified a number of other fragilities, too. First, companies that tap this market tend to be smaller and carry more debt than their counterparts with leveraged loans or public bonds. This makes them more vulnerable to rising rates and........
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