Eurozone may face pockets of stress from private credit, not systemic risk: ECB

[FRANKFURT] The eurozone is not facing systemic risk from the recent turbulence in private-credit markets, the European Central Bank (ECB) said in a report on Tuesday (May 26).

However, a few pockets of the financial system are exposed and some tension may already be visible, it added.

Signs of underlying stress in the fast-growing private-credit markets have been emerging in recent weeks, particularly in the US.

This raises concerns about broader financial stability, given the sector’s often opaque ties with more traditional banks and asset managers.

“Euro area financial institutions appear to have limited direct exposure to private credit,” the ECB said in a Financial Stability Report chapter.

“This makes it unlikely that private credit in isolation could be a source of systemic financial instability at present.”

Still, the ECB did not give the all-clear and warned that some sectors might be exposed to indirect stress.

The lack of regulatory visibility on the size and concentration of exposures could also weigh on sentiment.

“Insurance corporations and pension funds in particular could, in an adverse scenario, face more material second-round revaluation losses, from broader spillovers to leveraged loans, high-yield bonds and equities,” it added.

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While the eurozone’s overall exposure was small, it was concentrated among a few large players, the ECB said.

Insurance corporations’ exposure was estimated at 211 billion euros (S$313 billion) while for pension funds, the figure was estimated at 52 billion euros, it added.

Turbulence in private-credit markets started after several highly visible defaults, raising investor questions about underwriting standards and the opacity of the market, which faces less stringent supervision than traditional banking.

This has fuelled increasing redemption requests by investors, creating a large outflow of capital from private-credit markets, which forced some funds to cap outflows.

The ECB also noted that some private credit-reliant companies in the eurozone were showing deteriorating business prospects.

This is due to such funding often being provided to unrated, mid-sized companies with weaker credit quality, making them more exposed to any economic downturn.

The bank said: “The ability of private credit-backed companies in the euro area to service interest payments from operating cash flows has deteriorated in recent years.

“This trend can also be observed among firms funded through broader leveraged loan and high-yield bond markets, while it is absent for firms relying on bank loans.” REUTERS