Could private credit become the next global financial crisis? The question is gaining urgency across financial and regulatory circles after years of explosive growth in lending outside the traditional banking system created a market worth more than $1.8 trillion, much of it operating beyond close regulatory scrutiny. The concerns sharpened after JPMorgan Chase CEO Jamie Dimon warned that losses in the sector could exceed expectations once the credit cycle turns, citing deteriorating lending standards and rising leverage. Regulators are beginning to respond. The Financial Stability Board, which includes G20 central bank governors and finance ministers, has urged national regulators to tighten oversight of private credit markets. At the same time, the European Central Bank identified private credit as one of the leading threats to financial stability alongside elevated asset valuations. In its Financial Stability Review released in late May, the ECB highlighted two major vulnerabilities within the sector. The first was what it described as a “snowball effect,” with some funds struggling to liquidate assets while facing rising redemption requests from investors, increasing the risk of distressed sales. The second was the rise of “double leverage,” as private credit funds increasingly borrow from traditional banks to finance their own lending activity, creating deeper links between banks and nonbank lenders. Mohammed Farraj, senior executive for asset management at Arbah Capital, explained that the sector’s rapid expansion was rooted in structural shifts that followed the 2008 global financial crisis. As banks pulled back from lending to small and medium-sized companies under stricter Basel III capital and liquidity regulation, private credit funds moved in to fill the financing gap. Jamie Dimon, Chairman and Chief Executive officer (CEO) of JPMorgan Chase & Co. (JPM) speaks to the Economic Club of New York in Manhattan in New York City, US, April 23, 2024. (Reuters) “Their flexibility and ability to move quickly outside conventional banking restrictions allowed them to capture significant market share,” Farraj told Asharq Al-Awsat. Private credit refers to direct lending to companies through nonbank financial institutions without using banks or public debt markets. Unlike traditional banks, which rely on short-term deposits and operate under strict liquidity requirements, private credit funds are financed by long-term institutional capital from pension funds, insurers, and sovereign wealth funds. The sector encompasses a wide range of financing tools, including direct lending, mezzanine financing, distressed debt investing, startup financing, and asset-backed lending tied to real estate, equipment, or intellectual property. Years of ultra-low interest rates after 2008 accelerated institutional demand for private credit as investors searched for higher yields. More recently, higher global interest rates have made the sector even more attractive because many private credit loans carry floating rates that rise automatically with central bank tightening. Farraj argued that the current environment offers annual returns ranging from 10 percent to 15 percent, well above those available in traditional fixed-income markets. The company logo and trading information for BlackRock is displayed on a screen on the floor of the New York Stock Exchange (NYSE) in New York, US, March 30, 2017. (Reuters) However, he cautioned that higher borrowing costs are also placing growing pressure on heavily indebted companies, increasing the risk of defaults, particularly among businesses with fragile balance sheets. Transparency remains one of the sector’s biggest weaknesses. Private credit assets are not priced daily in public markets but are instead valued periodically using internal models, potentially delaying the recognition of losses and creating a misleading impression of stability. Concerns intensified earlier this year after a BlackRock private credit fund cut its net asset value by nearly 19 percent because of deteriorating technology-sector loans, prompting closer scrutiny from US regulators. Despite mounting concerns, Farraj maintained that private credit differs fundamentally from the 2008 mortgage crisis because losses are concentrated among sophisticated institutional investors rather than bank depositors. Still, he warned that hidden systemic risks could emerge through the growing ties between banks and private credit funds. He expected the sector to surpass $3 trillion in the coming years, driven by institutional demand and the expanding use of artificial intelligence in credit analysis and risk assessment.
