Private Credit in India: The Rise and the Rule

- Dr. Kishore Nuthalapati

Public markets: Borrowers, banks, investee firms, and intermediaries usually mobilize funds from public markets, be it equity or debt, primary or secondary, intermediated or disintermediated, domestic or cross-border, etc and the funds are usually widely dispersed. However, there are several borrowers, deal structures, assets, transactions, timelines, volumes, security features, etc., which do not fit in the public markets.

Alternative Investment Markets: Banks, due to regulations, could not fund transactions that do not fit into formats, have imperfect security, below investment grade, inordinate risk, lacks standard features, etc. Such transactions are served by Alternative Investment Markets. These markets are in existence for quite some time but gained huge traction in the past 4 decades. The size of global Alternatives Market is estimated at about $ 11 trillion with Private Equity and Real Estate being its dominant asset classes.

Private Credit markets: In due course, over 2 decades, Private Credit evolved and stood as 3rd largest asset class within Alternatives. International Monetary Fund (IMF), agency of the United Nations for managing global economic policies and which is the lender for its 190 member countries, puts the size of global Private Credit at $2 trillion. But other market reports suggest the size as $3.14 trillion. Majority of these amounts are invested in developing countries and in middle market firms serving multiple borrowers. Private Credit is also evidencing platform deals. For instance, in February 2024, Goldman Sachs signed $1 billion Private Credit deal with Mubadala Investment Company and announced its plans to have $110 billion assets under management (AUM) in Private Credit.  

The increasing volumes of Private Credit transactions made the financial system to track the growth. In the history of 30 editions of Global Financial Stability Report (GFSR) published by IMF, for the first time in its April 2024 edition, it has devoted a separate chapter on Private Credit presenting analysis, flagging potential risks, and suggesting regulatory measures. GFSR is widely read by the central banks, bankers, market players, economists, and business houses.

Indian scenario: India’s Private Credit markets have a size of about $15 billion which equals 4% of India’s total bank credit size. Funds to the Private Credit markets are supplied by Alternative Investment Funds (AIFs), Non Banking Finance Companies (NBFCs), Asset Reconstruction Companies (ARCs), Credit Mutual Funds, Private Equity (PE) funds, Venture Debt funds, High Networth Individuals (HNIs), Ultra High Networth Individuals (UHNIs), Hindu Undivided Families (HUFs), etc. In the matured economies the list includes Pension Funds, Insurance Companies, Sovereign Wealth Funds (SWFs), Trust Funds, Credit Societies, etc. Active players include KKR, Blackstone, Temasek, Carlyle, Bain Capital, Apax, ChrysCapital, Piramal, Edelweiss, Oak Tree, etc., but the list, deals, and volumes are fast growing.

Features & attractions: As Private Credit has mostly bilateral transactions, they are attractive to the participants for multiple reasons. They include confidentiality, flexibility, reliable intermediaries, minimal transaction costs, volume flexibility, quick turnaround time, network building opportunities, privacy on source of funds, no end use restrictions, collateral backed deals, etc. Specially for the investors, the absence of specific regulations, ease of tracking the deals, redeployment opportunities, higher returns coupled with lack of attractive opportunities in public credit markets are the additional reasons for operating in Private Credit markets.

AIFs in Private Credit: Not all players deem it regular or a business model to invest in or through Private Credit markets. The intermediation through vehicles is quite less than the intermediation through deals. In fact, for few players investing in Private Credit markets is ad hoc. But AIFs and NBFCs are active, regular, and dominant in Private Credit markets. As per the statistics of SEBI, two-thirds of total AIFs are category II which are broadly credit funds providing debt in Private Credit markets to middle market borrowers. As of 31st Dec 2023, all AIFs have put together raised commitments of Rs. 10.85 trillion, mobilized Rs. 4.30 trillion and invested Rs. 4 trillion. Of these, the Cat II AIFs have a share of more than 2/3rd with invested amount at Rs. 2.68 trillion.

Instruments in Private Credit: The instruments are non convertible debentures (NCDs), optionally convertible debentures (OCDs), inter corporate deposits (ICDs), share pledge agreements, agreements of sale, mortgage loan agreements, etc. These instruments are non standard and are customized. Since Private Credit markets have high risks, returns are commensurately higher. Typically, the credit tenures span between 5 to 7 years and the coupons range between 12% to 18%. Unlike in the developed countries, Indian Private Credit markets operate mostly on fixed coupon basis. Further, due to the flexibility in the instruments, certain settlements could happen by way of share purchases, realty purchases, etc. Comparable transactions in public markets would have been rated, disclosed, regulated, supervised, standardized, listed, collateralized, securitizable, and accelerable.

Banks & Private Credit: The terms and conditions of Private Credit will be influenced by the volumes, costs, terms, and deal structures of banks and others in the public markets. Tight public markets cause increase in the size and activity of Private Credit markets. Private Credit will be more active when public markets are down and less active when public markets are active.

It is rumoured that in the guise of structuring, few banks are doing select deals with essence being Private Credit. They also appear eager and keen to fund transactions of Private Credit scope if allowed. A deal of Private Credit market nature should not be served by banks. Correspondingly, deals of public markets nature should not be left for servicing by Private Credit market. Private Credit should neither be a pirate credit, nor should it curtail the sphere of the public markets.

Private Capital markets are always available, but cost is the driver and determinant factor. Several borrowers start and finish their credit shopping in Private Credit markets. This implies that Private Credit is successful in meeting needs of such borrowers that they are not sufficiently attracted by the public markets to explore institutional funding.

Risks of Private Credit: Private Credit is appreciable if used for asset creation, supporting additional working capital, or as a bridge funding. But, if Private Credit enters stock market, funds speculative real estate deals, funds gold or jewellery businesses, film production, etc., it entails huge risk. Private Credit markets should mobilize funds only with moderate leverage. Private Credit should not sponsor initial public offers (IPOs). If retail investors participate in Private Credit that is even more risky.

It is reported that in several Private Credit transactions the interest cover ratio is less than unity. However, until now, there are no instances of stress, no news of diversion of funds, no reporting of arbitrage deals from public markets to Private Credit markets, or any systemic issues. Fortunately, by nature, Private Credit do not have acceleration risks.

Regulations for Private Credit: Absence of regulation may cause volcanic rise of and dominant rule by the Private Credit markets. In its recent edition of GFSR 2024, IMF states that regulations for Private Credit should address credit risks, liquidity risks, leverage risks, asset valuation risks, interconnectedness risks, and conduct risks.

Comprehensive and valid data must be collected to take stock of exact volumes, inherent risks, systemic risks, interconnections between public markets and Private Credit markets, and possible impacts warranting specific regulation.

The rise and the rule of Private Credit requires regulation but that of soft and without ambiguity to avoid risk accumulation. Ambiguous or overenthusiastic regulation may discourage flow of funds into the market, asset creation, and even economic growth. Therefore, the regulatory measures should be timely, rational, productive, soft, and should facilitate healthy coexistence of public markets and Private Credit markets in the larger interest of the financial markets.

Disclaimer: Dr. Kishore Nuthalapati is an Economist, and is the CFO of BEKEM Infra Projects Pvt Ltd, Hyderabad, India. Views are his personal and do not reflect those of any of the organizations he is or was associated with.