Private credit: Are we prepared for a US-centric crisis that could put financial stability at risk in India?

In the eye of the swirl lies the US market for private credit—in which private equity (PE) firms deploy private investor funds, leveraged with loans from various sources, to lend outside the formal banking system to sundry borrowers.

Investors have been queuing up with redemption requests at the doors of PE funds—especially those feared to have overlent to AI-rattled software businesses. To honour these, firms need to run down their loan books, which may not always be possible; some players have resorted to extra borrowings to give investors their money back.

While this has compounded the crisis, many firms—such as Ares, Apollo and Blackrock—have been forced to limit redemptions.

This has all the typical signs of a gathering maelstrom, especially the investor rush to withdraw funds and affected firms taking on fresh debt to repay what they owe.

Things may reach a breaking point for many reasons, but the main issue for us is whether a similar crisis might afflict Indian financial markets.

In India, annual PE deals are estimated in a range of $30-40 billion, while assets under PE management are thought to be thrice as much or more. The local market is not huge, and may even seem tiny in contrast with America’s, but global PE firms operate in India and we must stay alert for potential contagion effects that may disturb financial stability here.

Unfortunately, this risk is not trivial. The Reserve Bank of India (RBI) has been issuing routine warnings about the adverse consequences of a possible blowout in the private-credit market, which forms an intricate web of links with other financial institutions.

So the country’s central bank, which tracks knock-on risks from one segment to another, may soon have to install guardrails in advance. Recall how RBI had acted pre-emptively to cushion the impact of America’s 2007-08 subprime lending crisis. Today’s troubles seem less serious, but private credit is also more opaque as a field.

Two issues hold importance here. The first is the unbridled tendency of fund managers to chase higher risk for higher returns, encouraged to a large degree by the waterfall incentive structure in PE firms, with big rewards for those on top. What gives them a licence is the lack of regulatory oversight, which emboldens managers to take on higher levels of risk.

This leads to the second problem: funds exploiting cracks in regulation and weak coordination among regulators. Notably, while all other lenders—from commercial banks to non-bank finance companies—must toe RBI’s line on prudential norms, PE players operate as ‘alternate investment funds,’ a category regulated by the Securities Exchange Board of India.

Decades ago, PE firms acted as equity investors; today, as a large part of their business, they lend. Ideally, all credit extenders should be regulated by RBI to ensure they meet capital adequacy, asset classification and income recognition norms. Otherwise, the overall credit market looks skewed, with one set of players burdened with safety rules and another free to go ‘all in’ on high-stake plays. This is a surefire formula for tragedy should a storm reach our shores.