Private credit has had a phenomenal run in Australia, attracting about $200 billion of new money to the sector over the past few years. This rapid expansion has raised alarm bells among financial experts, warning about the risks posed by the rapid expansion. Last year, almost 50 percent of private credit went to real estate. This has led to worries over sustainability and stability of our financial markets.
Not only is the Australian context ripe for the growth of private credit, so too is the entire global landscape. Though North America is still the largest market for private credit, Europe is rapidly catching up. Today, private credit sharks provide a little over 14 per cent of corporate loans in Australia. This rapid growth calls for much more scrutiny around what it means.
The Rise of Private Credit
There are four major reasons behind the recent private credit boom. One key driver is the increasing desire for new types of financing. With traditional banks pulling back on lending standards, businesses and investors have increasingly looked to private credit operators to fill that void. This trend, along with the increasing urgency around climate change, has led to a tidal wave of capital entering the sector, with Australian firms raising around $200 billion.
Significantly, roughly half of this private credit ends up going to real estate investments. One of the key attractions to investors in real estate is its predictability and stability. Consequently, this attraction has resulted in an increasing share of funds devoted to the sector. As capital continues to pour into the sector, fears of market saturation and overvaluation are starting to bubble up.
“My antenna goes up when things like that happen.” – Jamie Dimon
The quick growth of private credit is consistent with similar booms seen in the last several decades. This financial boom, popularly known as the great boom of the 1980s or the decade of greed, was made possible by a wave of financial deregulation. This history prompts a question of whether today’s environment could create similar liabilities in the financial system.
Regulatory Scrutiny and Vulnerabilities
The Australian Securities and Investments Commission (ASIC) has taken a watchful eye on the rapidly growing private credit market. Recent investigations found significant flaws in the industry. They zeroed in on the downfall of the First Guardian Master Fund and Shield Master Fund. These events have led ASIC to issue a private credit report that has left many industry participants unsettled.
This new report illuminates some of the other risks associated with private credit investments. This is particularly timely, given the increasing number of self managed superannuation funds (SMSFs) that exist outside the protective censorship of the Australian Prudential Regulatory Authority. Now worth around $4 trillion, Australia’s superannuation pool constitutes a massive liability for the economy if not prudently allocated.
More investors are diving into SMSFs, which account for around one quarter of the superannuation pool. As this trend accelerates, so do the worries about their exposure to unregulated financial products. This minimal oversight would result in a vastly increased level of systemic risk across the financial landscape.
“I probably shouldn’t say this, but when you see one cockroach, there are probably more. Everyone should be forewarned.” – Jamie Dimon
In doing so, Dimon underlines why we ought to be especially watchful given the current landscape playing out within the private credit industry. Read on to learn how more stakeholders are entering this evolving space. Moving forward, regulators and investors should be on the lookout for similar warning signs.
Implications for Financial Stability
The expansion of the private credit sector has important consequences for domestic financial stability in Australia. Experts warn that while private credit can provide necessary liquidity and financing options, it has the potential to destabilize the system if left unchecked. Nevertheless, private credit is inextricably linked to the public markets. So the question becomes, how do vulnerabilities increase in periods of economic stress?
North America overwhelmingly dominates private credit’s current participation. From startup entrepreneurs to family-run farms to big-box retailers, the demand is enormous—everyone is looking for financing alternatives. Development Australia continues to attract record interest from international investors. It will be critical for local regulators to craft a robust framework to ensure investors are protected and there is stability within the market.
This surge in private credit activity needs to be countered by robust regulatory action to protect against harms these practices cause. If we do not exercise rigorous oversight, Australia is in danger of following the financial crises of the past. If left unregulated, other dangerous market practices would have disastrous effects.
