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Private debt lands on IMF radar
A prolonged period of low interest rates and some of the highest historical returns across debt markets – with some of the lowest apparent volatility – have made private credit a favourite of investors of all shapes and sizes.
But the International Monetary Fund (IMF) says budding risks in the now US$2.1 trillion plus market require closer scrutiny from regulators as more and more money pours into it.
As private credit assets under management grow rapidly, and competition with investment banks on larger deals intensifies, supply-and-demand dynamics may shift, thereby lowering underwriting standards, raising the chance of credit losses in the asset class, and rendering risk management models obsolete,” the IMF says in its 2024 Global Financial Stability report.
“The private credit sector may also eventually experience falling risk premiums and weakening covenants as assets under management rise rapidly and the pressure to deploy capital increases… Authorities should consider a more active supervisory and regulatory approach to private credit, focusing on monitoring and risk management, leverage, interconnectedness, and concentration of exposures.”
The IMF namechecks five “fragilities” of private credit compared to traditional debt markets, including: companies in the sector tend to be smaller and more indebted proportionally; infrequent trading leaves loan valuations subject to potentially misleading risk models rather than mark-to-market bonds; possible ‘hidden’ leverage is hard to gauge given the lack or reliable data; concentration exposures and “interconnectedness” of investors; and rising liquidity risks as products targeting retail investors come on to the market.
“Private credit funds use long-term capital lockups and impose constraints on investor redemptions to align the investment horizon with the underlying illiquid assets,” the report says. “But new funds targeted at individual investors may have higher redemption risks. Although these risks are mitigated by liquidity management tools (such as gates and fixed redemption periods), they have not been tested in a severe runoff scenario.”
Despite noting that private credit has “created significant economic benefits”, the IMF says regulators need to improve data collection, monitoring, cross-border cooperation and reporting standards of the market.
“Overall, although these vulnerabilities currently do not pose a systemic risk to the broader financial sector, they may continue to build, with implications for the economy,” the report says. “Securities regulators should pay close attention to liquidity and conduct risk in private credit funds, especially retail, that may face higher redemption risks,” the report says.
