Huge growth in an “opaque” area of ​​global finance could pose a risk to overall market stability, the IMF warns

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• The rapid growth of the private sector could end up posing a risk to overall market stability, the IMF says.

• The “opaque” area of ​​financial markets grew to $2.1 trillion last year.

• Occasional valuations and unclear credit quality are risk factors in this area, the IMF said.

The rapid rise of the private lending industry could ultimately threaten financial stability given how little is actually known about the sector, the International Monetary Fund wrote in a blog post on Monday.

As more corporate lending moves from regulated banking institutions to less regulated entities such as private credit funds, risks grow as visibility into lending practices becomes opaque, the group said.

“The shift of this lending from regulated banks and more transparent public markets to the more opaque world of private lending poses potential risks,” analysts wrote on Monday, noting that the sector had over $2.1 trillion in assets and capital last year reached.

And since the start of the century, its returns have boomed, increasingly outperforming the S&P 500 and the MSCI World Index.

IMF

This industry emerged to provide much-needed financing for businesses deemed too risky for commercial lenders. Although the market is illiquid, the market's high returns, speed and flexibility have won over investors, the IMF wrote.

However, the sector is also largely unregulated and there are some worrying signs as a larger share of the credit market goes to retail loans.

“Appraisal is rare, credit quality is not always clear or easy to assess, and it is difficult to understand how systemic risks can build because the connections between private credit funds, private equity firms, commercial banks and investors are not entirely clear are.” analysts wrote.

First, borrowers are typically indebted companies that already rely on leveraged loans or public bonds. That means they face greater risk if interest rates rise, with a third of borrowers already facing interest costs that exceed returns, the IMF said.

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However, lenders are not tightening their lending standards because private loans face increasing competition from larger banks and the loans are rarely traded and therefore can be difficult to value.

Not only could private credit standards be worse than they seem, but analysts may not fully appreciate how closely linked the sector is to the broader financial system.

For example, banks may have a larger stake in personal loans than many realize, while pension funds and insurers have acquired more shares of these assets, the IMF said. Meanwhile, new funds are emerging that target individual investors and spread risk from Wall Street to Main Street.

Given these factors, private credit has the potential to deepen a recession whenever it occurs, one of the blog's authors said separately at a Brookings Institution event last week.

“I think we don't see any risk to financial stability, but … from a macrofinancial perspective, we don't know (how) the sector would function in a severe, prolonged recession given its size,” Fabio Natalucci told the pensions and investments industry news service.

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