Raghuram Rajan on Growing Private Credit Risks
In recent financial developments, Former RBI Governor
Raghuram Rajan issued a clear warning regarding the rising risks in the private
credit market. His concerns come at a time when the global financial
ecosystem is experiencing a surge in lending activity driven by excess
liquidity, strong private sector profits, and optimism around artificial
intelligence-led business expansion.
Speaking at the Clifford Capital Investor Day event in
Singapore, Rajan highlighted that the private credit sector has grown rapidly,
but without the same level of oversight or stress testing applied to
traditional banking institutions. According to him, the combination of ample
liquidity, lower interest rates, aggressive lending, and relaxed credit
standards is creating a fragile environment where risks may be
underestimated.
His statement also aligns with growing warnings from global
finance leaders, including Jeffrey Gundlach of DoubleLine Capital and JPMorgan
CEO Jamie Dimon. Recent corporate bankruptcies in the United States have
intensified discussions about whether the private credit boom could trigger the
next financial crisis.
What Is Private Credit?
Private credit, sometimes called private debt, refers
to lending activities carried out by non-bank institutions such as: Private
equity firms, Hedge funds, Alternative asset managers, Institutional credit
funds.
Unlike traditional bank loans, private credit deals are
negotiated privately between lenders and borrowers. These loans often target
companies that do not qualify for standard bank financing, either due to their
balance sheet structure, risk profile, or size.
The global private credit market has now crossed an
estimated value of $1.7 trillion, according to multiple financial
reports. The sector has grown rapidly due to higher return expectations
compared to conventional fixed income assets.
What Are the Risks in Private Credit?
As private credit expands, so do its challenges. Former
RBI Governor Rajan stressed that rapid growth without oversight can create
system-wide vulnerabilities. Some major private credit risks include:
1. Lack of Regulation
Traditional banks operate under strict regulatory frameworks
and undergo routine stress tests. In contrast, private credit firms are not
subject to the same scrutiny, leaving room for aggressive and risky lending
practices.
2. Limited Transparency
Private loan agreements are not publicly disclosed.
Investors often rely on limited reporting, creating information asymmetry
and difficulty in assessing true risk.
3. Liquidity Risk
Many private credit investments are illiquid. During
economic stress, lenders and investors may struggle to exit or restructure
deals.
4. Credit and Default Risk
Companies borrowing from private lenders typically do not
meet bank lending standards. This increases the likelihood of defaults when
market conditions shift.
5. High Leverage
Some deals involve multiple layers of debt, making repayment
structures complicated and vulnerable to financial shocks.
Is Private Credit Becoming a Systemic Risk?
Financial analysts are increasingly asking whether private
credit could become a systemic risk to the global financial system.
Raghuram Rajan and other experts believe that the rapid expansion of this
market without proper safeguards may introduce new vulnerabilities.
Jamie Dimon of JPMorgan warned that hidden financial
weaknesses could surface unexpectedly, comparing the situation to finding “one
cockroach” and knowing there are more.
The concern is not only defaults but the interconnected
structure of financial markets. If a major private credit lender collapses, it
could create cascading effects across investment portfolios, pension funds,
corporate borrowing, and liquidity channels.
Best Practices for Monitoring and Managing Private Credit Risk
Given both the benefits and risks, careful management is
key. Here are some best practices widespread among experienced investors
and credit managers.
1. Rigorous Due Diligence and Underwriting
Before committing capital, lenders and investors should
conduct detailed due diligence: assess the borrower’s financial history, cash
flows, business model, collateral quality, and potential for future stress.
Guard against overly optimistic assumptions or weak covenants.
Additionally, ensure loan covenants and terms have sensible
downside protections. Avoid covenant-lite structures unless absolutely
justified.
2. Avoid Over-concentration — Diversify Loans, Sectors,
Geographies
Diversification helps absorb shocks. Spread exposures across
multiple borrowers, industries and geographies rather than clustering in a
single sector. Limit leverage and avoid layering debt where possible.
3. Favor Experienced Managers with Strong Track Records
In private credit, the quality of fund managers matters.
Seasoned managers who have operated across cycles tend to understand risk
better, structure deals prudently, and navigate downturns cautiously.
4. Ensure Transparency, Regular Reporting and Valuation
Discipline
Even though private credit is more opaque by nature, insist
on regular and conservative valuations. Push for transparent reporting on fund
exposures, loan performance, defaults, and risky concentrations. This helps
uncover hidden problems early.
5. Stress Testing and Contingency Planning
Before investing or lending, run stress-test scenarios —
including economic downturns, rising interest rates, sectoral shocks or
liquidity freezes — to see how the portfolio holds up under stress. Have
contingency plans for defaults, liquidity crunches or refinancing difficulties
6. Monitor Macro Conditions and Market Signals
Private credit does not exist in a vacuum. Rising interest
rates, economic slowdown, tightening credit markets or regulatory changes can
all affect borrower capacity and investor returns. Keep a close watch on
macroeconomic trends and adjust risk stance accordingly.
Summary
Raghuram Rajan’s warning comes at a critical time. The
combination of easy liquidity, aggressive borrowing, and declining regulation
has created both opportunity and vulnerability in the private credit market.
While private credit offers diversification and attractive returns, it
also carries significant risks that should not be ignored.
With global financial leaders expressing similar concerns,
investors, regulators, and lending institutions may need to adopt robust risk
controls to avoid a future financial disruption.
As private credit continues to expand in 2025, the challenge
will be balancing innovation with responsibility, growth with stability, and
returns with financial safety.
Read also: Indian Economy 2025: Growth, Global Rank, Challenges
Frequently Asked Questions
1. What is private credit?
Private credit refers to loans and debt financing offered by
non-bank financial institutions such as private equity firms and credit funds.
2. Why is private credit considered risky?
It is less regulated, less transparent, often highly
leveraged, and difficult to exit in stressful economic conditions.
3. Can private credit cause a financial crisis?
Experts believe that if risks are ignored, rapid growth
could create systemic threats. However, proper risk management may reduce this
possibility.
4. What are the key benefits of private credit?
Higher returns, flexible deal structures, diversification,
and access to funding for companies who cannot rely on traditional banks.
5. Who should invest in private credit?
Only investors with strong financial knowledge, high risk tolerance, and long-term investment horizons should consider private credit exposure.
