The Bank of Canada is closely monitoring the growth of private credit, a lending model that has left Canadian investors and banks exposed to an estimated $500 billion in loans. The central bank's economists released a paper last week detailing why the sector deserves attention, and it flagged private credit as a risk in its May financial stability report.
Private credit broadly refers to loans from non-bank lenders, including asset managers, insurers and pension funds. For mid-sized businesses that are too large for traditional bank loans but not yet ready to issue debt on bond markets, private credit can be an attractive alternative. The global uptake of this model has expanded rapidly as firms seek fast and flexible financing, according to the Bank of Canada.
However, the central bank's analysis found that Canadian firms are not borrowing heavily through private credit. The share of loans from non-banks to domestic businesses has held steady at about 15 per cent over the past decade, suggesting, as the report's authors said, that "private credit has not been displacing traditional sources of funding." Instead, Canadian investors and banks are increasingly underwriting these loans, rather than taking them out directly.
As of the start of this year, the bank estimated a combined $500 billion in private lending by Canadian investors and lending to private credit funds by Canadian banks, with most of that exposure in the United States. While private lending in Canada primarily comes from life insurers, pension funds, and asset managers, the report noted that banks themselves are also involved, though perhaps counter-intuitively.
The Bank of Canada's assessment acknowledged the stability of insurers and pension funds as investors, while describing domestic asset managers as a "small but growing" segment. The central bank deemed the overall risks from private credit "manageable," but cautioned that "a sharp downturn in the performance of private credit abroad could affect Canadian investors and business lending in the domestic economy."
The concern stems from the potential ripple effects of high-profile bankruptcies tied to private credit. One example cited is First Brands Group, a Texas-based auto parts manufacturer largely financed by private credit, which filed for bankruptcy last year. Additionally, some major private credit funds capped withdrawals for investors in the spring, and several Canadian private real estate funds, including Trez Capital, Centurion Asset Management, and Avenue Living, have halted or limited withdrawals.
Peter MacKenzie, a senior policy analyst at the C.D. Howe Institute, expressed caution about the sector's lack of transparency and warned of the risk of overregulation. He noted that a panic in the U.S. could lead to a tightening of financial conditions and potential overregulation, which could have unintended consequences.
Conversely, Bruce Flatt, CEO of Brookfield Corp., a major Canadian asset manager, characterized the recent turbulence in the sector as a "healthy adjustment" rather than a "systemic problem." His view suggests that while there are growing pains, the overall stability of the financial system is not under threat.
As the private credit market continues to grow, the Bank of Canada's monitoring will likely intensify. The central bank's economists emphasized that the sector has not yet been tested by a prolonged market downturn, making it unclear what kind of ripple effects a shock could have on the financial system. Observers will be watching whether the current concerns are unfounded or a precursor to broader financial strains.