FSB warns on private credit vulnerabilities

Private credit has rapidly expanded to an estimated $1.5-2.0 trillion in assets by end-2024, heavily concentrated in a few jurisdictions.

The Financial Stability Board (FSB) highlights several vulnerabilities, including deepening interconnections with banks, insurers, and private equity firms.

Banks provide direct exposures of around $220 billion in drawn and undrawn credit lines to private credit funds, with commercial estimates ranging up to $500 billion.

The report warns that private credit borrowers typically exhibit lower credit quality and higher leverage than those in public markets.

Signs of stress include increased use of payment-in-kind arrangements and rising default rates, albeit from low levels.

Valuation opacity and reliance on private ratings also amplify strains, particularly given the concentration in sectors like technology, healthcare, and services.

The FSB report emphasizes that data gaps significantly hinder effective oversight of the private credit sector.

Differences in definitions across jurisdictions and limited fund- and loan-level information make it challenging to assess exposures and potential transmission channels.

The growing popularity of funds offering redemption options to investors may also heighten the procyclicality of private credit, posing liquidity issues.

To address these, the FSB encourages authorities to close data gaps, harmonise definitions for enhanced monitoring, and deepen analysis of financial interconnections and liquidity mismatches.

Authorities should also share supervisory approaches on risk management and governance for banks and non-banks active in private credit.