In the past two years, private credit has migrated from a niche corner of structured finance to a fixture of financial stability debates. In the first instalment of a new monthly OMFIF roundtable series, Money Disrupted, financial market experts laid out why.
The market has grown to an estimated $40tn globally, of which direct lending accounts for roughly $2tn, while insurance companies in the US and Canada now hold around 35% of their assets in private form. The figures are large enough to matter and opaque enough to worry about.
Scale, opacity and AI exposure
The opacity of private credit begins with how it is rated. Of roughly 8,000 ratings issued on these instruments, only around 1,000 came from the three major agencies; the remaining 7,000 came from specialised raters, some of whom are estimated to grade two to three notches more generously than their larger counterparts. The result is a market where ‘triple-A’ may not mean what it means elsewhere, and where the underlying collateral is too often invisible even to sophisticated participants.
That opacity has collided with a more immediate problem: exposure to software and artificial intelligence. Over the past year, spreads in high-yield bonds and leveraged loans linked to software and services firms have moved together, as markets re-evaluate the creditworthiness of companies whose large language models might threaten their business models.
The complication is timing. A disproportionate share of the private credit vehicles most exposed to this repricing face a refinancing wall over the next two years, raising the prospect of rollover risk precisely where credit quality is most in question. Default rates have so far stayed close to 1%, broadly comparable to high-yield bonds and bank loan books, and stress scenarios suggest a deterioration in line with those markets rather than a dramatically worse one.
Capped redemptions but uncapped risk
The instinct to compare today’s growth in asset-based finance to the pre-2008 securitisation boom is understandable, but the analogy breaks down on a key point: maturity transformation. In the run-up to the financial crisis, securitised products were repeatedly re-packaged and funded short term in money markets. Today’s asset-based finance vehicles, still dominated by banks rather than private credit funds, mostly avoid that structure. Where private credit funds do offer liquidity, redemptions are typically capped at 5%, a ceiling that did not exist for securitised products in 2008, and one that meaningfully blunts the risk of a disorderly run.
However, the reassurance has limits. Roughly a third of the $2tn in direct lending assets under management sits undeployed as so-called ‘dry powder’, often cited as a stabilising buffer against future defaults. But the distribution of that capital across firms is uneven and the incentive to deploy it during a downturn is not guaranteed.
Fund managers may prefer to hold it back as a safety valve rather than spend it on propping up deteriorating borrowers, which could, in turn, pressure underwriting standards precisely when they need to hold firm. Liquidity risk also extends beyond redemptions: direct lenders that have extended revolving credit facilities could face sudden demands for emergency funding in a ‘dash-for-cash’ scenario, without the central bank backstops that banks can rely on.
Interconnectivity and the regulatory gap
One deep concern is how tightly private credit, private equity and insurance have become entangled. A large share of direct lending flows to private equity-owned borrowers. But private equity-owned insurers have been notably more willing to allocate to private credit than their independently owned peers, raising questions about information advantages and conflicts of interest. Meanwhile, banks have significant exposure to non-banks through loan commitments and credit lines; for some institutions, total exposure to non-banks can be as high as 600% of core capital.
Cross-border data gaps compound the problem. Supervisory data generally are not shared across jurisdictions, and a meaningful share of private credit funds are domiciled offshore, where reporting requirements are lighter still. Regulators in the US, UK and Europe can each assess parts of their own systems, but no one has full visibility into how the pieces connect internationally.
Participants at the roundtable proposed taking an activities-based approach to oversight, tracking leverage, interconnectedness and substitutability, since the sheer multiplicity of entities involved makes entity-by-entity supervision impractical. But activities-based monitoring has its own blind spot: it can miss concentration risk sitting in a thin tail of poorly capitalised institutions, even when the aggregate picture looks manageable.
While the private credit market does not represent a systemic risk today, it is worth watching closely. Better data and possibly new backstops will be needed as the sector continues to scale. Whether that calibration holds may depend on how the market behaves the next time credit conditions genuinely deteriorate.
Andrea Correa is Head of Research at OMFIF.
Join OMFIF on 27 July for the second instalment of the Money Disrupted series: ‘Are bond yields structurally moving higher? Will bond vigilantes return?’
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