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Banks may find it galling to see lightly regulated private credit making inroads into their business. But by and large, the growth of the sector is good news for the financial system. Rather than turning short-term deposits into long-term loans (a mismatch that has been known to trip up banks), funds tap into genuinely long-term capital, broadly matching the duration of their loans.
Yet that is only true insofar as private credit sticks to its core mission. As the industry expands, and stretches its tendrils towards new investors and new investment opportunities, there are some areas that should start to attract regulatory scrutiny.
For one thing, private lending is becoming increasingly enmeshed with the traditional banking system. Banks strike partnership agreements with private credit funds, and lend them money. That is not necessarily concerning given that the debt gets sliced up and banks end up holding the less-risky tranches on their balance sheets. It is also still tiny in the context of banks’ loan books. But the overall exposure — and whether it becomes concentrated with some particular lenders, or some particular private credit managers — is worth keeping an eye on.
Another issue is private credit’s own loan quality. Where it engages in direct lending, it often serves riskier companies — especially now that banks and the syndicated loan market are again on hand for those seeking plain-vanilla debt. Payment-in-kind loans — which allow issuers to defer interest payments — have been rising, partly as a result of straitened companies seeking to refinance.
Whether this additional flexibility will just delay inevitable blow-ups — a drag on private credit groups themselves and the economy at large — or whether it will help fundamentally good companies find a path to profitability, is an open question. But as the private credit industry becomes bigger, regulators may be keen to delve more deeply into loan books.
Most obviously, any effort to attract high net worth, or even retail, money is destined for much hoop-jumping. Just think about the complexities involved in State Street and Apollo’s mooted public-private credit exchange traded fund, for which the companies requested approval in September. There are obvious questions around transparency, pricing and valuation — hard enough to do on a quarterly basis, let alone daily.
The question of liquidity is even more problematic. If more investors want to sell their ETF than there are buyers in the market, Apollo is on hand to buy a slice of the private loans to provide backstop liquidity. It may not need to, especially if the fledgling secondary market for private loans develops. But, as private credit expands, the age-old problem of how to turn short-term money into long-term loans may end up resurfacing in unexpected places.
camilla.palladino@ft.com
