Private Credit Funds Stabilize Markets, Research Shows

Certain private credit and debt funds can help stabilize the financial markets and promote economic resilience in times when banks are unable to loan money, new research finds. 

The rise of private debt funds following the 2008 recession has prompted some concern among regulators. But a paper published on February 13 and entitled “Nonbank Credit” finds that private credit funds can lend capital when it’s otherwise unavailable, which can smooth the credit cycle and, as a result, stabilize the market. 

“The starting point of the paper is this re-examination of the lending sector and what people call shadow banking,” said the paper’s author, Christina Parajon Skinner, assistant professor of legal studies and business ethics at the Wharton School at the University of Pennsylvania. “There’s been a lot of concern about non-bank lending.” 

Skinner also called for private debt funds to be open to a wider range of investors, arguing in the paper that these funds should be open to retail investors, rather than just sophisticated or accredited investors. 

The private credit industry is booming: it has quadrupled in size in the past ten years, according to the paper. What’s more, by 2020, the industry is expected to hold $1 trillion in assets under management, the paper said. 

The increase in private credit activity can be attributed, at least in part, to the 2008 recession. Banks at the time pulled back on their lending activities because of balance sheet concerns, according to the paper.  

Then came the Dodd-Frank Wall Street Reform and Consumer Protection Act and its Volcker Rule provision, which stipulates that banks cannot engage in proprietary trading, the paper said. Banks concerned about how the rule would be interpreted simply pulled back on their market making activity overall, rather than attempting to determine which activities they could continue to engage in, the paper said.

Those driving the boom include alternative asset managers like BlackRock, Blackstone, Cerberus, Oaktree Capital, and PIMCO, the paper said. They each raised new funds to supply credit to corporate borrowers who were otherwise unable to receive lending from banks, according to the paper.  

These institutions have essentially created three major types of private credit funds according to the paper: “the ‘plain vanilla’ direct lending fund, the rescue lending fund, and the Business Development Corporation.” 

“These private debt funds are structured to deploy their capital in a counter-cyclical way,” Skinner said by phone.  

In other words, when a downturn occurs, banks are encouraged to pull back on their lending, even as demand for credit and debt increases, the paper said. Private debt funds can take advantage of this by offering credit that banks would otherwise be unable to, the paper said. 

According to Skinner, the availability of lending through private credit firms can make economic downturns “less severe.” 

“We know from decades of experience is that what the economy needs to recover from a downturn is credit,” she added. “The growth of this sector can be a positive complement to bank-provided credit.”

Article from Institutional Investor