Increasingly, private firms that are not banks have gotten into the field of loaning businesses money. Some call it “shadow banking” — a way to borrow money without the same rules and regulations of a traditional bank. But that lack of transparency could lead to investor jitters, and it's been causing some anxiety lately.
Now, big private credit firms are stemming the outflow of investor dollars by enforcing caps and, in some cases, winding down funds altogether. Some see echoes of the last financial crisis; others say it’s not time to panic just yet.
“Marketplace Morning Report” host Sabri Ben-Achour spoke with Tomasz Piskorski, a professor at Columbia Business School, who reviewed 1,200 private credit funds covering most of the market. His recent paper, “Private Credit, Balance Sheets and Financial Stability,” argues we may not need to worry just yet. The following is an edited transcript of their conversation.
Sabri Ben-Achour: Whose money is in these companies? Like, who or what are the investors?
Tomasz Piskorski: They are primarily financed by equity pulled from limited partners. Typically, these limited partners are institutional investors — think about pension funds, money managers, family offices, university endowments. But recently, there was also a push to bring more retail investors into the private credit space.
Ben-Achour: Some of these private credit firms have told their investors you cannot take all of your money out right now, which sounds very sketchy. How much trouble is this sector in?
Piskorski: Private credit funds are structured very differently. They use long-term capital in the form of this equity investors. So when there is trouble and investors want to withdraw money, they cannot do it quickly. It's not necessarily good for investors, but it increases the stability of the system, because these funds do not have to liquidate the assets quickly, and it limits the potential of the run — like the run on banks we've seen in 2023.
Ben-Achour: People think back to the Great Financial Crisis. Why not be worried about it in that way?
Piskorski: Private credit funds are much more conservatively structured. Sixty-five to 70% of the capital comes from these limited partners, the equity holders, and the banks. The traditional banking sector has exposure to these private credit funds, but they only finance about 30% to 35% of the operations. For a typical bank to suffer a loss on the private credit fund loan, the assets of these funds would have to decline 60% to 70% compared to only 10% for a regular bank. So, in other words — to put it in layman's terms — the private credit funds just have much less debt use and much less leverage. And leverage is an important propagator of financial crisis.
Ben-Achour: On a scale of one to 10 of anxiety or worry — where one is no anxiety, and then 10 is like Great Financial Crisis-level anxiety — where should we be?
Piskorski: Regarding the private credit funds themselves, I would put it at four to five.
Ben-Achour: Is there anything that could happen in private credit that would raise your anxiety level?
Piskorski: So, I could imagine a situation when we have what I would call a “valuation contagion,” the fact that these private credit funds will start seeing outflows of limited partners and equity investors from them, that could result in general perception that quality of credit in the entire market — outside of private credit, too — is not great. What worries me more is the state of the banking sector in the U.S. The banks are still very heavily levered. They have exposure to rising interest rates, and interest rates are sticky; they're not going down. So, I think the system is not fully stable, and especially in the banking sector, there are a lot of hidden risks.
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