RBNZ to 'monitor developments' in the private credit sector, including its 'linkages with the financial system'

The Reserve Bank (RBNZ) says private credit is on the rise in New Zealand and it's monitoring developments.

A form of shadow banking, private credit involves non-bank entities lending money sourced from investors to businesses. It has been around for years but is booming with the International Monetary Fund (IMF) estimating the market topped US$2.1 billion last year in assets and committed capital. Bloomberg recently described private credit as "Wall Street's buzziest asset class." 

Lee Foulger, the Bank of England's Director of Financial Stability, Strategy and Risk, estimated earlier this year the private credit market has grown four-fold since 2015 to about US$1.8 trillion, noting limited data means the true market size could be much larger. And the Australian Financial Review last week wrote about "Australia’s A$200 billion unregulated private credit boom."

The RBNZ is tasked with maintaining financial stability in the domestic financial system. An RBNZ spokesperson told interest.co.nz private credit is increasing in NZ, with the role of offshore credit funds growing.

"In some cases, private credit firms compete with the banks for lending. In other cases, they lend jointly with banks through syndicated lending facilities to corporate borrowers. Based on recent discussions with New Zealand banks, financial stability risks arising from banks’ exposure to private capital investors, private equity and private credit, appear to be lower than in other countries, such as the United Kingdom," the RBNZ spokesperson said.

NZ banks’ exposure to private capital investors, both private equity and private credit, "is relatively low," our banks have simpler business models than UK banks, meaning their overall exposure to private capital is easier for them to monitor and track, and banks’ lending to private capital is focussed primarily on non-cyclical, non-discretionary industries where cashflows are less sensitive to economic conditions, said the RBNZ spokesperson.

"Given that growth in the private capital industry is likely to continue, we will monitor developments in the industry and its linkages with the financial system."

Capgemini's recent 28th annual World Wealth Report, which surveyed 3,119 high-net-worth people around the world, described private credit as "highly sought" to meet long-term return expectations while overcoming short-term market fluctuations.

The IMF notes over the past few years, private credit has grown rapidly given its speed, flexibility, and attentiveness have proved valuable to borrowers. Institutional investors such as pension funds and insurance companies have invested in funds, though illiquid, that have offered higher returns and less volatility.

"Private corporate credit has created significant economic benefits by providing long-term financing to corporate borrowers. However, the migration of this lending from regulated banks and more transparent public markets to the more opaque world of private credit creates potential risks. 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 IMF said recently.

"Today, immediate financial stability risks from private credit appear to be limited. However, given that this ecosystem is opaque and highly interconnected, and if fast growth continues with limited oversight, existing vulnerabilities could become a systemic risk for the broader financial system."

Foulger said private credit has become an increasingly important source of funding for some corporates and sectors such as real estate, providing an alternative source of financing including for those who might have otherwise found it hard to secure finance through public markets or from banks.

"The availability of private credit can be beneficial for economic activity and innovation. By providing finance where traditional means fall short, it can support investment and growth opportunities. And to the extent that private credit substitutes for bank financing, it can contribute to the diversification of financing sources. In many ways lending via private markets is likely to be lower risk from a financial stability perspective than had the lending been undertaken by the pre-Global Financial Crisis banking system," he said.

Non-banks contributed nearly all the £425 billion net increase in lending to UK businesses between 2008 to 2023, said Foulger.

"That means it is important that, alongside banks, the non-bank system can absorb, and not worsen, any shocks that may arise."

"Corporates that borrow through private credit markets, along with leveraged loan and high yield bond markets, are likely to be more challenged in a higher interest rate period. The floating-rate debt structure of private credit agreements makes them vulnerable to challenges around debt servicing and refinancing in a higher rate environment. To date, private credit market participants have reported low default rates despite the tougher macro environment. But in the past year, highly leveraged borrowers have experienced a significant decline in their interest coverage ratios," Foulger said.

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