ECB warns eurozone banks on hidden risks in private equity

The European Central Bank (ECB) has raised concerns that eurozone banks may not fully understand their exposure to the rapidly expanding private credit and equity markets. As a result, the ECB announced on Wednesday that it plans to set new risk management guidelines for lenders in this area.

ECB warns eurozone banks on hidden risks in private equity

Private credit funds have seen significant growth in recent years, often supported by bank financing, while private equity funds are increasingly leveraging, leading to a more opaque landscape. The ECB, after conducting a survey of banks, warned that lenders might not have a clear picture of their true exposure. “The failure to accurately identify, at an aggregate level, exposures to companies that also borrow from private credit funds means that this exposure is almost certainly understated, leading to potential mismanagement of concentration risk,” the ECB said in its Supervision Newsletter.

Focus on co-lending

One of the main challenges highlighted is that banks may act as co-lenders to companies that also tap private credit funds, where the same bank could be exposed through another channel. The ECB noted that banks typically manage such risks by product type or client type, which does not provide a comprehensive view of the risks posed by these exposures. Other concerns include banks’ heavy reliance on valuations provided by private funds and limited data availability due to the often opaque nature of the private equity and private credit sectors.

Potential solutions

To address these issues, the ECB intends to establish new supervisory standards for managing risks related to private credit and equity fund exposures. “Banks will be required to submit details of their risk management strategies along with a gap analysis relative to the ECB’s forthcoming expectations,” the ECB stated. It will then engage with individual banks to ensure compliance with the new supervisory standards.