The Federal Reserve is examining the risks associated with private-credit firms, which have become one of the fastest-growing categories of borrowers for banks. Following the 2008 financial crisis, banks retreated from risky lending, but they have since returned to this practice by providing loans to nonbank institutions. According to FDIC data, loans to these institutions increased from $300 billion in 2016 to over $1.5 trillion, now comprising 11% of all outstanding bank loans.
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These loans are often secured by the private-credit firms' own debt, raising concerns among regulators. The European Central Bank has also intensified its investigation into private credit, particularly regarding banks' exposures to the sector. Recently, the Securities and Exchange Commission issued a reminder to lenders about the importance of accurate valuations and disclosures for private assets.
During its September meeting, the Bank of England's Financial Policy Committee highlighted vulnerabilities in private credit amid worsening financial conditions. Earlier this year, the private credit market faced turmoil as investors grew anxious about certain funds with significant investments in software companies, particularly following advancements in artificial intelligence. This led to record withdrawal rates from some funds, with investors attempting to pull nearly 40% of their investments in a single quarter, although withdrawal limits are generally capped at 5%.
Concerns have been raised about how private credit lenders assess the value of their loans, often resulting in discrepancies among lenders regarding the valuation of the same loan. Lenders defend their practices by using third-party evaluators for loan assessments and emphasize their commitment to careful investment strategies. Recently, redemption rates have declined at several private-credit firms, and a number of investors have renewed interest in software investments as options for financing have broadened in and outside the private credit market.