Two US senators, Sherrod Brown (D-Ohio) and Jack Reed (D-R.I.), have written to Federal Reserve chair Jerome Powell and vice chair of supervision Michael Barr about their concerns regarding the regulation of private credit.

In the letter, dated 20 December 2024, the pair said that analysis of the private credit market pointed to “emerging vulnerabilities and potential risks to financial stability and the banking system” from private credit.

“Companies borrowing in the private credit market tend to be smaller and carry more debt than companies with traditional capital structures,” they said. “In addition, private loan valuations are more opaque, and often more generous, than valuations set by public markets.

“Furthermore, private credit investors, funds, and borrowers often employ multiple layers of leverage to enhance returns, and these layers of interconnected debt are typically not visible to regulators because of gaps in reporting.”

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The two senators went on to describe their concern around private credit funds seeking to “compete on banks’ turf”.

“Private credit fund managers and industry consultants expect future growth in areas where traditional banks are projected to reduce their activity, such as asset-backed finance,” they said.

“As one fund sponsor notes, ‘we believe the next chapter in the private credit story is the migration of asset-backed finance toward alternative capital providers.’ In other words, private credit funds see an opportunity to take share from banks’ traditional business, while avoiding traditional regulatory oversight.”

Brown and Reed suggested that research had found that banks prefer to lend to business development companies (BDCs), rather than to those businesses directly, because of preferential regulatory capital treatment of loans to BDCs. They also raised concerns around private credit’s increasing take up of synthetic risk transfers (SRTs).

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“As they pursue unbridled growth, private credit managers are seeking out ways to sell to individual investors, raising concerns that individuals may end up with illiquid and opaque product – despite promises to the contrary in the offering documents,” the pair said.

They concluded by calling on the Federal Reserve to “prioritise data collection and risk monitoring of the private credit sector” urging it to examine private credit’s links with the traditional banking system to look for hidden risks.

“To ensure continued financial stability, the Federal Reserve and other financial regulators must take steps to comprehensively supervise the ties between banks and private credit firms. As the private credit market continues to strengthen its bonds with banks, Americans will be relying on you to ensure the continued safety and soundness of the banking system,” they said.

The letter follows one outlining similar concerns in November 2023.

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