Monetary Policy & Inflation | US
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Summary
- Private credit is growing strongly but represents only about 10% of financial liabilities in the non-financial corporate sector.
- Foreigners and to a lesser extent financial companies are the main providers of non-bank loans.
- Private credit is unlikely to threaten financial stability as corporate leverage aligns with historical trends. By contrast, government leverage has more than tripled over the past 20 years.
Market Implications
- I do not expect private credit to constrain monetary policy and still expect no cut in 2024.
Private Credit Is a Small Share of Corporate Borrowings
In this note, I argue the growth in private credit is probably not the biggest threat to financial stability.
Private credit consists of non-publicly traded debt issued by non-bank financial businesses to fund mid-market firms, typically with revenues between $10mn and $1bn. Private credit took off after the GFC due to banks’ regulatory constraints and attractive yields, about 2-4ppt over leveraged loans. This follows decades of bank consolidation and growth in non-bank lending, of which private credit is a subset.
Private credit has become more visible over the past few years and has been eliciting strong interest from regulators, think tanks, international institutions, and even the US Congress. Data is hard to obtain but a Federal Reserve (Fed) note estimated US outstanding private credit instruments represent $1.2tn (end-2023, Chart 1).
Non-financial corporate sector financial accounts indicates the importance of private credit (Table 1). The $1.2tn the Fed estimated at end-2023 represents only about 5% of the total liabilities of the non-financial corporate sector and about half of non-bank lending. Other non-bank lending consists broadly syndicated loans that typically involve many more lenders, tending to be more liquid than private credit as well as leasing, factoring, or trade credit to smaller borrowers.
Table 1 aggregates financial data from mid and large corporates and only the latter can easily access the securities market. Were data for mid-market firms available, it would likely show a bigger funding role for banks and private credit.
‘Other loans’, which include private credit, have become a more important source of business funding since 2018. Meanwhile, debt securities have become less important, and banks’ role have been roughly unchanged (Chart 2). This likely reflects private credit investors, who currently have about $0.5tn in dry powder, increasingly funding larger borrowers.
Private credit investors are typically pension funds, insurance companies, sovereign wealth funds, wealthy individuals, and family offices. A deep dive in the ‘other loans category’ indicates their relative importance.
Foreigners Main Providers of Non-Bank Lending
The Rest of the World (i.e., foreign investors) are the main non-bank loan provider, including private credit, to the nonfinancial corporate sector, accounting 40% of outstanding ‘other loans’ (Table 2). This reflects the US current account deficit, which is funded through foreigners acquiring US assets. This category includes sovereign wealth funds that at-end 2021 owned about 10% of private credit Accounts Under Management.
The next four largest loan suppliers, finance companies, Asset-Backed Security (ABS) issuers, government and mutual funds, which account 50% of other loans, are generally not participants in the private credit market. However, a few mutual funds and some ABS issuers are participants.
Investors likely to be involved in private credit (i.e., wealthy individuals) (part of the household sector), life insurers, and broker dealers, account less than 10% of ‘total loans.’ Pension funds do not appear in Table 2, likely because they do not hold private credit assets directly but rather through intermediaries.
Historically, most of the recent increase in non-bank lending has come from the rest of the world and to a lesser extent from finance companies (Chart 3).
Private Credit Not Biggest Threat to Financial Stability
Discussion of the impact of private credit on financial stability typically balances the lower data availability inherent to a private market against the greater flexibility associated with a closer relationship between borrowers and lenders than in traditional lending. This closer relationship has several advantages (e.g., tailored credit terms, greater nimbleness, easier monitoring of borrower performance, and easier renegotiation of credit terms during periods of stress).
Furthermore, while private credit lenders are not funded by deposits and therefore not exposed to runs, they tend to rely on banks for their funding. Bank lending to non-depository financial institutions have tripled since 2015 (Chart 4). By contrast, their commercial and industrial lending has been flat since Q4 2022.
Overall, I do not find the expansion in private credit concerning. Rather, it seems an efficient response to the post-GFC regulatory tightening imposed on banks and to a long-term trend of banking concentration.
This is largely because corporate sector debt has been falling relative to GDP since its 2020 peak and longer term is on a very gradual uptrend. By contrast, relative to GDP, government debt is the highest ever outside of wars and more than three times higher than it was in 2000. Therefore, I see the government as a more likely source of long-term financial instability than private credit.
Market Consequences
I do not expect private credit to constrain monetary policy over the next year or so and I still expect no Fed cut in 2024.
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Dominique Dwor-Frecaut is a macro strategist based in Southern California. She has worked on EM and DMs at hedge funds, on the sell side, the NY Fed , the IMF and the World Bank. She publishes the blog Macro Sis that discusses the drivers of macro returns.
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