By FRANKFURT (Reuters) – Euro zone lenders may not have a full understanding of their exposure to the quickly growing private credit and equity markets, so bank supervisors plan to outline new risk management expectations, the European Central Bank said on Wednesday.
Private credit funds have grown quickly in recent years, partly using bank finance, while private equity funds are taking on greater leverage, creating a more opaque environment in which banks may not fully understand their actual exposure, the ECB said after surveying lenders.
“The failure to properly identify – on an aggregate level – exposures to companies that also borrow from private credit funds means that this exposure is almost certainly understated and the concentration risk cannot be properly identified and managed,” the ECB said in a Supervision Newsletter.
A key problem is that a bank may be a co-lender to a portfolio company, which also relies on private credit funds, where the same bank could have exposure via a different channel.
“Banks typically manage such risks either at product type level or at client type level,” said the ECB, which directly supervises just over a 100 of the euro area’s biggest banks. “This approach fails to holistically capture the risks generated by these exposures.”
Other issues include excessive reliance on valuations provided by funds and data scarcity given the often opaque nature of the private equity and private credit markets, the ECB said.
To mitigate this risk, the ECB plans new supervisory expectations for the risk management of exposures to private equity and private credit funds, it said.
“Banks will be asked to submit information on their risk management approach as well as a gap assessment against the ECB’s expectations,” it said.
The ECB will then follow up with banks on an individual basis to ensure that the supervisory expectations are met.