The Bank for International Settlements (BIS) has raised concerns about the growing vulnerability of the private credit sector to liquidity mismatches, particularly as it increasingly draws capital from retail investors, according to a report by Bloomberg.
In a report published Tuesday, the BIS warned that the sector’s shift toward structures allowing retail investors to regularly redeem investments could expose private credit to risks similar to those faced by traditional lenders during periods of market stress.
Historically, direct lenders have provided long-term loans that match the duration of their funds, a setup that has allowed the industry to assert that private credit poses minimal systemic risk.
However, as money managers tap into retail investor capital, with many funds now offering more frequent redemption options, the risk of liquidity mismatches has risen. If market conditions deteriorate and investors seek to withdraw capital, funds may struggle to meet those demands without being forced to sell assets at depressed prices.
The report adds to a growing chorus of warnings from regulators and industry watchdogs who are scrutinising the private credit sector, which now holds $2.5tn in assets, according to BIS estimates.
The Financial Conduct Authority recently highlighted issues with private market valuations, including conflicts of interest, inadequate record-keeping, and volatility smoothing, which could further exacerbate risks in the sector.
Retail investors are expected to become the fastest-growing source of capital for private assets through 2032, according to Bain & Co.
In light of this, the BIS report suggests that private credit funds may face challenges balancing the benefits of sector-specific lending with the need for greater diversification to reduce exposure to potential risks. Failure to achieve such diversification could dilute competitive advantages, the report warns, and could even become a regulatory requirement in some markets.
The report also notes that the recent slowdown in private credit fundraising, attributed to rising interest rates, could complicate the sector’s ability to adapt to these evolving risks.
In a related analysis, the BIS observed that bond mutual funds face significant outflows during periods of market stress, potentially exacerbating credit market tightening.
This stands in contrast to bond ETFs and prime money market funds, which typically experience slower but less severe outflows. The BIS cautioned that investor flows leading to asset sales could have greater systemic repercussions if they occur during times of heightened pressure on traditional banks, posing a threat to financial stability.
