Private credit is not a financial stability risk, but could worsen a recession — IMF official

Private credit is not a risk to financial stability, but it could potentially worsen a future recession, said Fabio Natalucci, deputy director of the monetary and capital markets department at the International Monetary Fund.

“I think we don’t see a financial stability risk, but … from a macro-financial standpoint, we don't know (how) the sector, given the size, would operate under a severe prolonged recession,” Natalucci said at an April 4 event on private credit hosted by the Brookings Institution.

“Do you mean if we have a recession, could this make the recession worse?” asked David Wessel, director of Brookings’ Hutchins Center on Fiscal and Monetary Policy and senior fellow in economic studies.

“Yes, that’s what I mean,” Natalucci responded, adding that private credit could be an “amplifier,” given financial interconnectedness.

Wessel brought up the “unusual” recession which occurred at the beginning of the COVID-19 pandemic, which Natalucci agreed was unusual, citing the high level of intervention from the Federal Reserve.

“So (private credit) hasn’t really been stress-tested?” Wessel asked Natalucci.

“It hasn’t been stress-tested in a prolonged recession where the authority would not react that massively,” Natalucci said.

Critics grow

Critics of private credit are emerging, including a March study from the National Bureau of Economic Research that found "rates at which private debt funds lend appear to be high enough to offset the funds’ fees and risks, but not high enough to exceed both their fees and investors' risk-adjusted rates of return."

The private credit industry has attracted new critics in Washington as well. Earlier this week, Sen. Elizabeth Warren, D-Mass., said, "I have been warning about the dangers of private equity for years," while participating in a congressional hearing April 3 discussing the negative consequences of private equity-owned healthcare facilities.

And in November, Senate Banking Committee Chair Sherrod Brown, D-Ohio, and Sen. Jack Reed, D-R.I., who serves as a member of the committee, urged federal regulators to monitor the risks that private credit could pose to the financial system, citing what they said is a lack of regulatory oversight.

Natalucci also identified the private credit market’s opacity and lack of data as two risks of the asset class, naming liquidity mismatch and leverage as others.

But Natalucci acknowledged there are some benefits to private credit.

“One (benefit) is the viability of funding, so you expand the set of funding opportunities so (there’s) less concentration of funding from the banking sector, for example, that has been at the center of a number of financial crises,” he said, adding there are various benefits to private credit borrowers as well.

Natalucci noted that the IMF is set to publish its Global Financial Stability Report on April 8. The fund’s Global Financial Stability Report from April 2023 partly echoed Natalucci’s concerns about private credit, as the report said it’s “a relatively new asset class, with performance untested in a prolonged economic downturn.”