FRANKFURT, May 26 (Reuters) – The euro zone is not facing systemic risk from the recent turbulence in private credit markets but a few pockets of the financial system are exposed and some tension may already be visible, the European Central Bank said in a report on Tuesday.
Signs of underlying stress in the fast-growing private credit markets have been emerging in recent weeks, particularly in the U.S., raising 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 may be exposed to indirect stress and 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,” the ECB added.
While the euro zone’s overall exposure was small, it was concentrated among a few large players and insurance corporations’ exposure was estimated at €211 billion while for pension funds, the figure was estimated at €52 billion, the ECB said.
Turbulence in private credit markets started after several highly visible defaults, which raised 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 firms in the euro zone were also showing deteriorating business prospects since such funding is often provided to unrated, mid-sized companies with weaker credit quality, making them more exposed to any economic downturn.
“The ability of private credit-backed firms in the euro area to service interest payments from operating cash flows has deteriorated in recent years,” the bank said. “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.”
(Reporting by Balazs KoranyiEditing by Keith Weir)
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