Private credit is not just safe; it's vital to the US economy

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Everything is opaque when you are wearing a blindfold. Critics of direct lending from private credit funds often falsely claim that the industry's "opacity" leaves regulators blind to risk in the financial system. A new MFA study demonstrates how those opacity assertions give short shrift to the detailed data that is provided to regulators of all stripes. The study identifies the myriad of information private credit funds provide state and federal officials about their loans. This data gives policymakers abundant insight into an industry that enhances financial stability and benefits many Americans.

Loans from private credit funds are a frequently misunderstood driver of American economic growth. The lending fuels businesses across the country, providing American companies with nearly $2 trillion in capital to innovate, create jobs and bolster our economy. The returns generated enable pensions to provide comfortable retirements, foundations to support community programs and endowments to fund scholarships. 

The risk posed by direct lending from the private credit industry, while providing capital to businesses in the form of loans, is structurally different from the risk posed by bank lending. Funds are not banks. They are not interconnected like banks. And they do not pose a systemic risk like banks do.

Private credit funds do not have depositors who can pull their money in the blink of an eye. Funds have investors who take investment risk and bear any losses. These investors commit their capital for long periods of time, and do not enjoy a government backstop. The activity is also dispersed among thousands of funds and lacks the concentration of the banking system.

It stands to reason that the regulatory regime for direct lending from private funds is also different than the banking system. It is fit for the industry it is designed to monitor.

Direct lending from private credit funds enhances the stability of the U.S. financial system by removing risk from highly interconnected depository institutions. Federal Reserve officials, among others, have noted the benefits of transferring the risks from banks to private funds. And research shows that direct lending from private credit funds provides stability to the U.S. economy during turbulent times and is less prone to creating the conditions for extreme declines in growth than other forms of credit. 

Policymakers should preserve the benefits of private credit direct lending for the U.S. economy by making full use of the data already available to help with market surveillance.

Private credit funds are subject to a raft of reporting requirements from agencies, like the U.S. Securities and Exchange Commission at the federal level and the secretaries of state or the equivalent in all 50 states. These filings provide a wealth of information that helps regulators understand the health of the industry.

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The SEC, for example, collects two reports that allow it to monitor direct loans from private credit funds: Business Development Company, or BDC, reports and Form PF. BDC reports provide regulators with detailed information on individual portfolio holdings, giving a clear view of the investments of private credit funds. Form PF enables regulators to monitor individual private credit funds to identify potential threats to financial stability. 

Also at a national level, prudential banking regulators, like the Fed, have visibility into private credit funds through bank call reports. These reports provide banking regulators with several types of creditor financial information and details on bank relationships to private funds. This data allows regulators to see the flow of credit within the economy and assess potential financial stability risks.

At the state level, the information gets even more granular. Uniform Commercial Code, or UCC, filings provide a public record of individual collateralized loans provided by private credit funds that regulators and other stakeholders can easily access. 

States also have lending licensing and reporting requirements to ensure direct loans from private credit funds comply with consumer protection laws and lending regulations. As a part of these requirements funds report loan performance metrics, including default rates, delinquencies, recovery efforts, prepayment rates and any modifications or restructurings of loan term.

Simply put, those who claim that private credit direct lending is opaque are wrong. Data on direct loans from private credit funds are plentiful and readily available. 

Unfortunately, misconceptions about private credit direct lending continue to persist. For example, former Comptroller of the Currency Eugene Ludwig recently asserted in a BankThink piece (Private credit markets are a $1.7 trillion ticking time bomb, November 18, 2024) that private credit funds are "unregulated." It is crucial that such views don't lead to policy decisions that burden an industry that supports so many businesses and boosts our overall economic security. To the extent there are perceived data gaps, regulators should work together to coordinate and compile the different pieces of information private lenders already provide and then assess needs. Far from being "opaque," private credit direct lending data is, in fact, available. To say otherwise is misleading.