Private credit is a rapidly expanding field. Companies bypassing banks and bond markets to borrow directly from private funds have seen significant growth in recent years. This swift expansion has caused global regulators to worry about risks to financial stability. However, a more fundamental question is whether this practice supports the ultimate goal of the financial system: real economic growth.
Historically, companies seeking loans would turn to banks. In the early 20th century, the largest and most reliable companies began issuing bonds to investors, emulating governments. By the early 1990s, entrepreneurial financiers opened public debt markets to smaller and riskier companies by leveraging the crisis in the U.S. savings and loan industry. Today, high-yield corporate bonds are a $3 trillion global asset class.
Private credit is a more recent innovation. It emerged at the turn of the millennium as a financing source for companies seeking more than what commercial bank loans could offer but not large enough to access the bond market. The 2007-2008 global banking collapse provided significant momentum for this financing source. The IMF estimates that this source grew from $0.5 trillion a decade ago to $2.1 trillion last year. JPMorgan analysts, however, put the total at over $3.1 trillion. Meanwhile, more than 85% of private credit deals are now larger than $1 billion.
The IMF recently highlighted potential risks associated with this rapid growth. The creditworthiness of borrowers is a concern. On average, companies using private credit employ more leverage compared to their public market counterparts. Additionally, private credit often comes with variable interest rates, making companies more vulnerable to interest rate fluctuations. Private credit funds frequently borrow from banks as well. Furthermore, there is the issue of accurate and timely valuation. As with all private assets, the lack of a transparent secondary market means that investors could face significant and sudden losses.
