This post was originally published on this site.
Closer supervisory attention could make banks more cautious about lending against private credit collateral, tightening funding for nonbank lenders and possibly raising borrowing costs for the mid-sized companies that rely on them. Bank stocks with large lending to nonbank financial firms may face more questions on disclosure and collateral valuations during the upcoming earnings season. The link to AI disruption risk in software loans adds a new channel through which tech-sector weakness could reach credit markets. The review also lands as broader risk assets look complacent compared with stress in sovereign bonds, so any sign of trouble in private credit could add to pressure on credit spreads.
The Fed is knocking on Wall Street’s door to check what is really backing more than $1.5 trillion of bank lending to the shadow lenders.
Summary:
- The New York Fed has been reviewing major banks’ lending to private credit firms since the spring, Semafor reports.
- Officials met JPMorgan, Wells Fargo, Barclays and Morgan Stanley, focusing on exposures, risk management and collateral quality.
- The review was partly prompted by JPMorgan’s March markdowns of loans to private credit firms, notably software loans seen as vulnerable to AI.
- Reviews have been completed at some banks, including JPMorgan. The Fed and the banks declined to comment.
- Bank lending to nonbank institutions has grown from around $300 billion in 2016 to more than $1.5 trillion, about 11% of all bank loans.
- The visits follow an April Fed request for exposure data and parallel Treasury questioning of insurers.
The Federal Reserve Bank of New York has been examining how exposed some of the largest banks are to private credit firms, according to a report by Semafor (gated), in a sign that regulators are taking a closer look at one of the fastest-growing corners of the financial system.
Fed officials have met with JPMorgan Chase, Wells Fargo, Barclays and Morgan Stanley since the spring, questioning the banks on their overall exposure to private credit lenders, their risk management practices and the quality of the collateral backing those loans, the report said. Reviews have already been completed at some of the banks, including JPMorgan. The Fed and the four banks declined to comment.
The scrutiny was partly prompted by JPMorgan’s decision in March to mark down the value of loans to private credit firms, particularly loans to software companies seen as vulnerable to disruption from artificial intelligence. Because those loans serve as collateral when private credit funds borrow from banks, the markdowns reduced the amount of financing available to the lenders themselves.
The scale of the links between banks and nonbank lenders explains the focus. Bank lending to nonbank financial institutions has grown from around $300 billion in 2016 to more than $1.5 trillion, or roughly 11% of all bank loans, according to the Semafor report.
The visits build on earlier steps. In April the Fed asked major banks for details of their exposure to private credit firms, focusing on how much the funds had borrowed from banks, as it tried to gauge stress in the sector and the risk of spillover. At the same time, the Treasury Department questioned insurers about their own private credit holdings. The private credit industry, estimated at about $1.8 trillion at the time, was facing a rise in redemption requests and problem loans.
Other regulators are also paying closer attention. The Securities and Exchange Commission recently issued guidance on how private assets should be valued, while the European Central Bank and the Bank of England have expanded their own reviews of private credit vulnerabilities and valuation practices.
The review does not by itself signal losses at the banks involved, but it suggests supervisors want firmer evidence that collateral values and risk controls would hold up if conditions in private credit deteriorate further.
This article was written by Eamonn Sheridan at investinglive.com.
