The European Central Bank is escalating its scrutiny of lenders’ exposures to private markets amid concerns that the fast ascent of related asset classes raises substantial new risks.
The watchdog has signalled that it’s sending letters to executives at certain banks cautioning them on their practices in financing private funds, according to people familiar with the matter.
In another indication of the ECB’s determination, it plans to conduct on-site investigations on the matter at several major European banks, the people said. The regulator’s staff recently visited Société Générale SA in one of the first such exercises, they said.
Spokespeople for the ECB and SocGen declined to comment.
Regulators around the world have been alarmed by the rapid expansion of private credit as investors pour money into funds that aren’t subject to the same strict oversight as banks.
Traditional lenders, which are sometimes exposed to companies that are owned by private equity or borrow from private credit funds, have been seeking to tap into that growth by providing various forms of leverage to such funds and their managers.
The ECB’s moves escalate a review that started last year. Bloomberg reported at the time that the supervisor had asked top banks, including major French and German lenders, for details of their exposure to private credit firms as well as their lending to funds operating in the space.
The review found that banks aren’t able to properly identify the detailed nature and levels of their full exposure to private credit funds.
Direct lenders initially stepped in to finance companies that banks dropped in the face of stricter regulation after the 2008 financial crisis.
Yet the industry is increasingly challenging incumbents in other deals, arguing that it can offer quicker due diligence and better service.
US banks have seen the volume of their loans to private debt funds soar 145% over the past five years. Bank exposure to both business development companies – which pool direct loans – and other types of private debt vehicles reached about $95 billion (€83.69 billion) by the end of 2024, according to a Federal Reserve report published last week.
While European banks are generally less involved in private equity and debt than US competitors, a number of them “do have high exposures, and the contribution this segment makes to their profits is considerable,” the ECB said in November.
Private credit has been expanding rapidly, yet regulatory scrutiny may indirectly dampen that growth in Europe, according to bankers.
Letters to banks are a key tool for the ECB to clarify how it thinks the industry should approach certain issues. The watchdog can escalate further if it concludes that lenders are ignoring the contents of its missives.
Yet the scrutiny also risks feeding into a narrative among bankers that the watchdog’s concerns about systemic risk from private markets is unfairly bleeding through to its oversight of individual banks. That follows similar allegations of overreach with relation to leveraged loans, a more established business for European banks.
Two senior bankers told Bloomberg that credit ratings have emerged as a key area of contention with the ECB. The watchdog has queried cases where lenders didn’t have such costly assessments for individual counterparties or financing they provide to private credit firms, they said.
At least one bank has started taking out insurance on credit facilities it grants to direct lenders so as to reduce the impact on its own capital levels. This bank has had to turn down business with private credit players, also as a result of the lengthy interactions that are needed with the ECB, said one of the bankers.
While base fees charged to private credit firms as well as ancillary services are still lucrative, the added protection essentially wipes out much of the interest income from such loans, said one of the bankers.
The ECB said in November that banks’ risk management hadn’t caught up with market developments. “Given that the exposures involve complex, multi-layered risks, with leverage entering at several levels, sophisticated approaches are key to effectively managing these risks,” it said at the time.
(With additional reporting from Esteban Duarte)
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