New Federal Reserve Report: Financial Stability Risks from Private Credit Funds “Appear Limited”

This week, the Federal Reserve Board released its semiannual Financial Stability Report which evaluates various risks in the financial markets, and makes general observations about any new financial stability concerns. 

This Report included a specific private capital section with an analysis of risks posed by private credit. Notably, the report concluded that private credit does not pose financial stability risk, or that such risk is “limited.” Specifically, it highlighted the relatively low leverage in private credit, and that investor redemption risk is low. Further, the Report notes private credit funds engage in limited liquidity and maturity transformation. On page 54, the Report clearly concludes:

“Overall, the financial stability vulnerabilities posed by private credit funds appear limited. Most private credit funds use little leverage and have low redemption risks, making it unlikely that these funds would amplify market stress.”

Additionally, two economists at the Federal Reserve Board of Governors just published a new paper that highlights how private equity firms help reduce credit risk. As Institutional Investor reported: 

“New research shows that private equity firms can help reduce the credit risk of companies and pare the losses that lenders can expect to take. Private equity firms are able to do this by either reducing the volatility of sales and collateral backing loans — operational engineering — or by improving the financial situation of a distressed company.”

“The findings appeared in a new paper published last week by economists Sharjil Haque and Teng Wang of the Federal Reserve’s Board of Governors, along with Simon Mayer from HEC Paris. According to the researchers, the results suggest that the actions of private equity firms can “substitute for bank monitoring in containing credit risk.”

“‘PE-backed loans appear to have lower credit risk relative to comparable non-PE-backed loans, at least when measured by expected losses,’ the researchers wrote.”