Sens. Sherrod Brown (D-Ohio) and Jack Reed (D-R.I.) reiterated their recommendations that federal banking regulators take action to protect Americans against the growing risks posed by the private credit market in a letter to Federal Reserve Chair Jerome Powell and Vice Chair of Supervision Michael Barr.
The lawmakers highlighted their concerns about the implications to consumers as the marketplace grows in size, complexity, and interdependence with the banks.
“To ensure continued financial stability, the Federal Reserve and other financial regulators must take steps to comprehensively supervise the ties between banks and private credit firms,” the senators wrote. “As the private credit market continues to strengthen its bonds with banks, Americans will be relying on you to ensure the continued safety and soundness of the banking system.”
The senators claimed there is a lack of transparency and only minimal oversight of the private credit market that must be addressed, referring to a report published by the International Monetary Fund in April 2024.
“As you know, U.S. and foreign regulators continue to analyze private credit markets and identify emerging vulnerabilities and potential risks to financial stability and the banking system,” the lawmakers wrote. “Their work points to mounting threats, including that companies borrowing in the private credit market tend to be smaller and carry more debt than companies with traditional capital structures. In addition, private loan valuations are more opaque, and often more generous, than valuations set by public markets.”
They also asserted private credit investors, funds, and borrowers frequently employ multiple layers of leverage to enhance profits, which are typically not visible to regulators because of gaps in reporting.
“The lack of information about these transactions harms other market participants, as the broader market loses insight into the condition of troubled companies or industries,” the senators continued. “As firms or industries turn exclusively to private credit, a limited group of asset managers will have a view into changes in the outlook for both individual companies and broad parts of the economy that would previously have been widely available to market observers. Researchers have raised concerns that this lack of information may make it more difficult for markets to price in business conditions, potentially leading to an increase in sudden, unexpected shocks.”
The private credit sector’s expressed desire to continue to grow by relying on increasingly complex structures and soliciting new investors to deliver additional capital also have raised concerns for the lawmakers. They noted private credit fund managers and industry consultants expect future growth in areas where traditional banks are projected to reduce their activity, such as asset-backed finance.
“As one fund sponsor notes, ‘we believe the next chapter in the private credit story is the migration of asset-backed finance (ABF) toward alternative capital providers,’” the senators wrote. “In other words, private credit funds see an opportunity to take share from banks’ traditional business, while avoiding traditional regulatory oversight.”
They closed the letter by emphasizing the need for the Fed to prioritize data collection and risk monitoring of the private credit sector, specifically with respect to its links with the traditional banking system where there could be hidden risks for examiners to expose.
Brown and Reed wrote the Fed in November 2023 urging regulators to address growing risks posed by the private credit sector to protect the safety and soundness of the banking system.