The International Monetary Fund stated in a blog post on Monday that given how little is truly known about the private credit market, its explosive growth may end up endangering financial stability. 

Potential Risks

Risks increase as lending methods become less transparent and more loans to businesses are transferred from licensed banking institutions to less regulated companies like private credit funds, according to the group.

Analysts noted on Monday that the private credit industry surpassed $2.1 trillion in assets and capital last year.

“The migration of this lending from regulated banks and more transparent public markets to the more opaque world of private credit creates potential risks,” they said.

Additionally, since the year 2000, its returns have increased dramatically, consistently outpacing both the MSCI World index and the S&P 500. This sector of the economy developed to supply much-needed funding for businesses that commercial lenders regarded too risky.

The IMF stated that investors have been won over by the market’s substantial returns, rapidity, and flexibility despite its lack of liquidity.

However, there are also some concerning indicators as a growing portion of the lending market shifts to private credit, and the industry is essentially unregulated.

“Valuation is infrequent, credit quality isn’t always clear or easy to assess, and it’s hard to understand how systemic risks may be building given the less than clear interconnections between private credit funds, private equity firms, commercial banks, and investors,” the analysts wrote.

Private Credit

First off, most borrowers are already indebted businesses that depend on public bonds or leveraged loans.

According to the IMF, a third of borrowers currently have interest rate payments that exceed their profits, which puts them at greater risk when interest rates climb.

Despite the fact that private credit is becoming a more formidable rival to the larger banks and that the loans are often hard to value, credit providers aren’t strengthening their lending rules.

Analysts could not completely understand how intertwined the industry is with the larger financial system, in addition to the possibility that private credit standards are worse than they seem.