Boom and bust cycles, driven by human emotions of fear and greed, have long dictated the financial markets. Despite advancements in intelligence, both real and artificial, these cycles persist, often leading to catastrophic financial outcomes. The latest focus is on private credit—a sector operating outside traditional banking rules and increasingly seen as a potential destabilizer of the financial system.
Historically, financial booms have often been fueled by deregulation, lax credit standards, or innovative financial practices that escape regulatory oversight. The 1980s saw a boom driven by financial deregulation, while the early 2000s experienced a similar surge due to the financialization of assets, culminating in the Global Financial Crisis. Today, the stock market is again in a frenzy, propelled by a handful of US-based technology giants, and concerns are mounting about the ballooning debt levels across governments, households, and corporations.
The Rise of Private Credit
Private credit, often described as the alter ego of private equity, has been gaining attention for its potential systemic risks. As traditional banks face stricter regulations post-Global Financial Crisis, non-bank lenders have stepped in to fill the gap, providing loans to riskier borrowers. These lenders raise capital from wealthy individuals and institutional investors, offering loans at higher rates than banks, but with significantly greater risk.
According to the Reserve Bank, private credit quadrupled over the decade leading up to 2023, reaching $US2.1 trillion globally, and is believed to have grown to $US3 trillion since. The majority of this capital is concentrated in the United States, with Europe rapidly catching up.
“Non-bank lenders have played an increasingly large role in lending to risky companies, in part because some business lending has become more expensive for banks; regulatory reforms after the global financial crisis raised banks’ capital requirements,” noted a report last year.
Warnings from Industry Leaders
JP Morgan Chase CEO Jamie Dimon recently issued a stark warning about the potential dangers lurking within the private credit sector. His comments came on the heels of financial troubles faced by US auto financing groups like Tricolor Holdings and First Brands Group, both of which had tapped into private credit markets to lend to sub-prime borrowers.
“I probably shouldn’t say this, but when you see one cockroach, there are probably more. Everyone should be forewarned,” Dimon stated.
The allure of private credit lies in its profitability during boom times, as lenders can charge a premium over traditional bank lending rates. However, the risks are magnified as the sector grows, largely unregulated and lacking transparency.
Australia’s Foray into Private Credit
In Australia, the private credit market has also gained traction, particularly among self-managed super funds (SMSFs) and major funds seeking higher returns. The Australian Securities and Investment Commission (ASIC) has been investigating the vulnerabilities within this sector, particularly following the $1 billion collapse of the First Guardian Master Fund and Shield Master Fund.
Approximately 25% of Australia’s $4 trillion superannuation pool is self-managed and not under the purview of the Australian Prudential Regulatory Authority. Many of these funds have invested in private credit, drawn by the attractive returns.
Private credit operators now provide around 14% of the loans to Australian corporations, with a significant portion directed towards commercial real estate and property developers.
The real estate sector, with its high upfront costs and delayed returns, is particularly reliant on non-bank lenders. This reliance is reminiscent of past financial debacles involving firms like Fincorp, Westpoint, and Australian Capital Reserve, which collapsed in the mid-2000s after using debentures to raise capital.
Regulatory Concerns and Future Outlook
ASIC’s recent report on private credit highlights several concerning practices, including conflicts of interest, fee gouging, and inadequate loan security. The report marks the beginning of a regulatory strategy to better monitor this expanding sector and raise industry standards.
While private credit has the potential to play a beneficial role if properly regulated, its current trajectory raises alarms. As the global financial landscape becomes increasingly saturated with debt, the unchecked growth of private credit could trigger a shift from greed to fear among investors.
The financial industry faces a critical juncture. Learning from past mistakes and implementing robust oversight could prevent another crisis, but the path forward remains fraught with uncertainty.
