Private debt’s rapid growth merits closer scrutiny, IMF says

April 9, 2024 (Preqin News) – The rapid growth of private credit requires careful monitoring, the International Monetary Fund (IMF) has suggested, citing concerns about the asset class as a potential risk to financial stability.

As private credit transaction values and volumes continue to grow, so do concerns about liquidity risks in pension fund and insurer investments, the agency says in its latest Global Financial Stability Report. Prudential oversight of private credit markets remains limited in scope, raising a risk that any vulnerabilities in the asset class could become systemic, it says.

The IMF’s report recommends that authorities be encouraged to ‘consider a more intrusive supervisory and regulatory approach to private credit funds, their institutional investors, and leverage providers.’ It follows similar recent warnings from policymakers concerning the growth in credit from ‘non-traditional’ lenders.

Investor demand for private credit grew rapidly in the decade after the Global Financial Crisis (GFC) as investors sought higher returns amid a near-zero interest rate environment. Borrower demand has increased as other sources of capital, particularly bank loans, have been harder to access.

The post-GFC decade has also seen increasing allocations to private markets by large investors such as insurers and pension funds, a trend that is expected to continue. According to the Preqin 2024 Global Report: Private Debt, private credit AUM will hit $2.8tn by 2028, almost double the 2022 figure of $1.5tn.

In its report, the IMF states that the instability risks that private credit pose are currently contained as loans use modest leverage and capital is locked up in the long term. However, its concerns largely center around potential future scenarios.

‘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 IMF says in a report chapter entitled The Rise and Risks of Private Credit.

The fund says that while private credit firms have increased lending capacity, they lack the same regulatory scrutiny that is faced by more established institutions such as banks.

‘The current regulatory framework, similarly, does not specify asset valuation methodologies, focusing on policy documentation, governance frameworks, and investor disclosures,’ it says.

In addition to the regulatory and supervisory approach, the agency’s recommendations also include undertaking cross-border and cross-sectoral cooperation to bridge data gaps, as well as closely monitoring and addressing funds’ liquidity and conduct risks, particularly in retail funds that could face higher redemption risks.

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