Rapid private credit growth, growing 'interconnectedness' with banks and NBFIs can create vulnerabilities: RBI report

Reserve Bank of India

The rapid growth of private credit and increasing interconnectedness with banks and NBFIs can create vulnerabilities, the Reserve Bank of India’s (RBI) financial stability report, released on June 27, has said.

“The rapid growth of private credit, increasing interconnectedness with banks and NBFIs and opacity can create vulnerabilities that could become systemic,” the FSR said.

Private credit, essentially provided by non-bank lenders to business on a bilateral basis, has grown four-fold over the past 10 years, emerging as a major source of corporate financing among middle-market firms that have low or negative earnings, high leverage, and lack of high quality collateral, the report said.

The key dimensions through which these risks could be propagated are riskier borrowers than counterparts in traditional lending spaces who could generate outsized losses, investors, particularly insurance companies and pension funds, who could experience large capital losses with systemic implications, and private credit structures are becoming complex, adding multiple layers of leverage.

Further, the report said liquidity risks amplified by growing retail presence and higher redemption rights, and interconnectedness with other segments of financial system.

Banks are increasingly accessing private credit market in ways that allow them to manage regulatory costs and generate fee-based income whereas insurers and pension funds are increasing their exposure to less-liquid investments.

Meanwhile, private equity (PE) firms are increasing their ownership stakes in life insurance companies and banks are originating their own private credit deals using minority stakes in private debt funds and business development companies, report said.