Private Credit Could Threaten Financial Stability, Create Huge Losses, IMF Warns

Pension funds, sovereign wealth funds, insurance firms and family offices ‘could be caught unaware by a dramatic rerating of credit risks across the asset class.’


Citing the potential risks and opaque nature of the rapidly growing private credit market, the International Monetary Fund is calling on authorities to consider a more proactive supervisory and regulatory approach to the asset class, which it said, “requires careful monitoring.”

The IMF warned in its recently released Global Financial Stability report that “the interconnections and potential contagion risks” faced by many large financial institutions due to exposure to the asset class are “poorly understood and highly opaque.” The report identifies vulnerabilities created by “relatively fragile borrowers,” as well as the increased exposure of pensions and insurers to private credit.

In its report, the IMF said that the migration of credit provision, which is the estimation of potential losses a company might experience due to credit risk, from regulated banks and public markets to private credit firms creates several potential vulnerabilities.

“Whereas bank loans are subject to strong prudential regulation and supervisory oversight, and bond markets and broadly syndicated loans to comprehensive disclosure requirements that foster market discipline and price discovery, private markets are comparatively lightly regulated and more opaque,” the report stated.

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The report noted that private credit loans are unrated, rarely traded, and are typically marked to model by third-party pricing services without standardized contract terms, adding that “rising risks and their potential implications may therefore be difficult to detect in advance.” It also warned that “severe data gaps” prevent a thorough and accurate assessment of how private credit affects financial stability.

“Because the private credit sector has rapidly grown, it has never experienced a severe downturn at its current size and scope, and many features designed to mitigate risks have not yet been tested,” the report stated. Although the report said that “immediate risks may seem contained,” it warned that because the private credit “has meaningful vulnerabilities,” and is growing rapidly under limited oversight, that “if these trends continue, private credit vulnerabilities may become systemic.”

Some of these vulnerabilities, the report cautioned, could generate “large, unexpected losses in a downturn,” particularly because private credit investments involve relatively small borrowers with high leverage.

“Some insurance and pension companies have significantly expanded their investments in private credit and other illiquid investments,” the report said. “Without better insight into the performance of underlying credits, these firms and their regulators could be caught unaware by a dramatic rerating of credit risks across the asset class.”

The IMF’s report recommends authorities should take a more “intrusive supervisory and regulatory approach to private credit funds, their institutional investors, and leverage providers.” It also suggests closing data gaps so that regulators can assess risks more comprehensively, closely monitoring and addressing liquidity and conduct risks in funds, and implementing product design and liquidity management recommendations from the Financial Stability Board and the International Organization of Securities Commissions.

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