The international spotlight is currently fixed on Iran, amid fears of a prolonged conflict in the Middle East that has already driven oil and gas prices to alarming heights.

As businesses and consumers brace for another significant energy shock and the resulting strain on living costs, a looming crisis within the financial system is causing considerable concern among experts.

If this financial threat materializes, it could unleash chaos reminiscent of the 2008 financial meltdown when interbank lending came to a halt.

Recent corporate failures across the United States and Europe have cast a shadow over the hidden realm of ‘private credit,’ a sector now under intense scrutiny as warning signs multiply.

The term ‘private credit’ refers to a relatively obscure funding avenue that expanded rapidly after the 2008 crisis, as traditional banks pulled back from higher-risk lending.

Functioning much like unregulated ‘shadow banks,’ private credit entities extend loans to companies that prefer to avoid the transparency and oversight of public stock markets.

Together with its bigger and better-known cousin, private equity – which owns shares in unlisted firms – private credit has grown into an £8.2 trillion industry dominated by some of the biggest names in high finance, including Blackstone, Apollo, KKR, BlackRock and Blue Owl.

Jamie Dimon – boss of JP Morgan, the world’s biggest bank (pictured with New York governor Kathy Hochul) – warned that more ‘cockroaches’ would crawl out of the financial woodwork

Crucially, these non-banks can’t take deposits from savers like regulated mainstream lenders do. 

Instead, these ‘alternative asset managers’ raise money from pension funds, insurers and other backers, which they then lend to private companies in the hope of making big returns.

The lure of these returns has attracted mainstream banks, which lent to the private credit funds. This link has fuelled fears that an implosion in the sector could spread to the wider financial system.

These concerns have ramped up because, from next month, British savers will be allowed to invest in private credit funds through individual savings accounts.

Worries about the private credit market began last year when two US firms suddenly imploded, raising fears that lending standards by shadow banks had become too lax. The collapses prompted Jamie Dimon – boss of JP Morgan, the world’s biggest bank – to warn that more ‘cockroaches’ would crawl out of the financial woodwork.

It wasn’t long before he was proven correct. Last month, the crisis reached the UK when Market Financial Solutions, a London-based mortgage broker that specialised in property-backed loans, suddenly keeled over, leaving creditors such as Barclays and Santander facing an estimated £1.3 billion shortfall.

The blow-ups prompted some private credit investors to head for the exit, only to find their escape route blocked after major players slammed the door shut in a bid to prevent a mass outflow of cash.

BlackRock, the world’s largest asset manager, capped withdrawals from its flagship private credit fund at 5 per cent after investors sought to withdraw nearly double that. 

Meanwhile, fellow fund manager Blackstone has been forced to scramble to meet a record £2.8 billion in withdrawal requests, while Blue Owl has barred investors from taking their money out of one of its retail-focused funds.

JP Morgan has also curbed lending to private credit, while investment bank Morgan Stanley halted withdrawals from a private credit fund after investors tried to pull out more than 10 per cent of their holdings.

Last week Christian Stracke, president of £1.7 trillion asset manager Pimco, warned the private credit industry was facing ‘a reckoning’. ‘It’s not just a crisis of confidence, it’s a crisis of really bad underwriting,’ he said, referring to concerns that the checks made on firms who borrow from private credit funds may not be as robust as previously thought. 

But the lack of liquidity when investors want out, coupled with poor transparency, is a feature, not a bug, of the sector. The loans don’t trade on exchanges. Instead, the funds that hold them decide how much they are worth, and investors can only sell a limited amount of what they own during time-limited ‘windows’.

Comparisons are being drawn with the sub-prime mortgage crisis that triggered the 2008 crash. Both involve complex financial structures that obscure who holds the risk. And both involve loans to borrowers that mainstream banks have shunned.

Private credit has grown into an £8.2 trillion industry dominated by the likes of Apollo and Blackstone. The latter has been forced to scramble to meet a record £2.8 billion in withdrawal requests

The private credit market is smaller than that of sub-prime mortgages in 2007, and lenders insist their loan default rates, while rising, are manageable.

But the Bank of England is worried enough to launch its own stress test to better understand the links between private credit and the wider financial system.

We have been here before. In 2022, the Bank was forced to bail out the pensions industry after the disastrous Liz Truss mini-Budget exposed hidden borrowing in workplace retirement schemes, forcing funds to sell precious assets to avoid collapse.

Pension savers on both sides of the Pond can only hope that history is not about to repeat itself.

One trigger could be artificial intelligence (AI). Private credit piled into the debt of software companies during the boom years but AI threatens to upend their business models as the new technology automates entire workflows that used to be done by humans using a variety of software services.

‘If investors start to worry about private credit, or something else, it is their more liquid assets, such as listed equities, that they may rush to sell first,’ says Fergus McCorkell of Troy Asset Management.

He also notes that previous eras of light oversight, abundant credit and ‘financial innovation’ all ended in tears. There is little to suggest it will be any different this time.

Check if your savings are at risk

By Anne Ashworth

The private credit industry may seem too rarefied to have any connection with your finances – but you would feel the impact from an implosion in the sector, whose shockwaves could spread to bond markets and banks.

The lenders have funded some of the private credit boom. If those that are heavily exposed were to suffer widespread defaults on these loans, it could force them to limit or stop lending to businesses and individuals.

A slice of your pension pot could already be directly invested in private credit, since fund managers are already committing cash to the sector as a result of government pressure.

If, like many people, you have opted for your scheme’s default funds, it’s worth checking into which areas your contributions are being directed.

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