Basel IV set to benefit private credit
Tougher capital rules on banks are expected to propel the continued boom of the private credit market.
In the EU, Basel IV – also known as Basel 3.1 – began implementation on 1 January 2023, seeking to address new emerging risks facing the banking system. Banks have five years to comply with the updated rules.
And in the UK, the Prudential Regulation Authority (PRA) is set to publish its final Basel IV credit risk approach in the second quarter of this year. The package will be phased in from 1 July 2025 to 1 January 2030.
Analysts have predicted that the updated rules will benefit non-bank lenders.
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“More stringent capital regulation imposed to banks in the wake of Basel IV has limited banks’ capacity to lend, particularly to the more leveraged borrowers, pushing them toward other financing sources,” said Guillaume Lucien-Baugas, VP – senior analyst at Moody’s Investors Service.
“The fact that private credit funds have lighter regulation (no capital rules, no heavy reporting duties, little risk management rules, little leverage constraints, little concentration limits) made them a perfect offset for banks’ relative withdrawal.
“The more-leveraged less-standard borrowers, rebuffed by banks due to regulatory constraints, have also had difficulties to be funded in the public markets – broadly syndicated loans and high-yield bonds – therefore finding alternative in the private credit markets.
“Basel IV has increased banks’ capital requirements, thereby reducing their lending capacity. This, in turn, has favoured private credit.”
Read more: Moody’s predicts ongoing boom in European private credit
Nicolas Charnay and Richard Barnes, both senior directors in S&P Global Ratings’ Financial Services Ratings team, said that the main driver of the impact is the introduction of the output floor, which sets a minimum for the risk-weighting (RW) of assets, to be phased in until the end of 2030.
“For exposures to unrated corporates in particular, the standardized approach under Basel sets the RWs at 100 per cent, which is potentially higher than what banks using their internal models would have set as RWs,” they added.
Charnay noted that in the EU, the regulator has assuaged the potential cliff-edge effect of this new rule by allowing a RW of 65 per cent for unrated, investment-grade companies until 2032.
“The segment of unrated non-investment grade corporate will therefore gradually become more capital intensive for larger banks which typically use internal models and will become bound by the output floor over time, and therefore the competition from non-bank bank lenders could intensify,” he said.
Read more: Private credit secondaries become more popular, paving way for GP-led deals
Meanwhile, in the UK, the PRA’s consultation paper proposed two standardised approaches for unrated corporates: a risk-sensitive approach where firms can differentiate between investment grade (65 per cent) and non-investment grade (135 per cent) exposures, and a risk-neutral approach where all unrated corporates are risk weighted at 100 per cent.
Barnes highlighted that the PRA proposed a consistent approach to the output floor, with no changes for the transition period, in contrast to its EU counterpart.
