This is a worrying development. The recent bankruptcies of US companies such as First Brands and Tricolor have focused attention on the private credit market, when a loan is provided by an entity other than a bank, and the potential risks that come with its growth.
Exposed to Tricolor’s $170 million debt, the establishment is examining its credit portfolio to identify other potential cases.
Animal metaphor also on the side of the governor of the Bank of England, Andrew Bailey, who estimated this week that it was too early to know if these were isolated cases or if these bankruptcies constituted “the canary in the coal mine” that heralded a crisis similar to that of 2008.
How did the private credit market develop?
Their exact size is difficult to quantify due to their opacity (these are over-the-counter loans) and disagreements over what falls into this category. But it grew rapidly as traditional banks abandoned some financing due to regulations aimed at limiting their risk-taking.
The truth is that they have connections with these non-bank financial institutions (NBFIs in English), which turn out to be competitors but also clients.
Thus, bank loans to NBFIs have more than doubled since 2019 to exceed $1 trillion by the end of 2024, according to a report by S&P Global, considering them a source of “risks and rewards.”
On the one hand, the advantage is not forcing the bank to have excessively high regulatory reserves but, on the other hand, it loses visibility on the potential risk of the end client.
Why the sudden concern?
The growing role of NBFIs has not escaped the attention of supervisory authorities, in particular the US central bank (Fed), which has invented a scenario of “rapid deterioration” in the quality of the assets of these non-bank entities.
Total bank losses were estimated in June at around $490 billion, an amount that large banks are “well positioned to significantly bear.”
However, concerns have grown about banks’ exposure to the bankruptcies of First Brands, a supplier to automakers, and Tricolor, an auto lending organization. In both cases accusations of fraud arose.
The fear is that a slowdown in the economy could lead to wider problems related to the proliferation of bad loans in recent years, especially after the astronomical sums of money poured out by central banks during the Covid-19 pandemic.
Are we at risk of a full-scale financial crisis?
It is too early to say, but the market reaction to the results published in mid-October by the banks suggests that this issue is on their radars, but without predicting a future catastrophe.
However, the quotes of several mid-sized banks stumbled on October 16 after regional bank Zions Bancorporation revealed that it was going to initiate proceedings against a borrower for fraud and a 50 million exposure.
At this stage, the problem appears to be limited to “a few bad apples,” said Stuart Plesser, an analyst at S&P Global.
However, according to him, recent cases illustrate the need to tighten granting conditions by NBFIs, particularly because sometimes the same asset has been used by a borrower to guarantee several private loans.
A big unknown too: the consequences that a significant deterioration in the labor market would have.
Given the rapid growth in lending to NBFIs, “that’s likely to change at some point,” Peter Orszag, chief executive of French-American investment bank Lazard, said on CNBC this week. But “I don’t think that’s what we’re going through today.”
Source: BFM TV
