Private Credit Dynamics

A Mubadala and Goldman Sachs Strategic Partnership

Goldman Sachs has reportedly struck a $1 billion private credit pact with Mubadala Investment Company to fund Asia-based transactions.

Mubadala, headquartered in Abu Dhabi, is a sovereign wealth fund owned by the Emirate of Abu Dhabi, United Arab Emirates. As one of the world's largest and most active sovereign wealth funds, Mubadala manages a diversified portfolio of investments across various sectors, including technology, energy, aerospace, real estate, and financial services. It often engages in strategic partnerships and investments globally, aiming to generate sustainable returns and contribute to the economic diversification and growth of the Emirate of Abu Dhabi.

This particular deal with Goldman Sachs highlights Mubadala's continued focus on deploying capital strategically to support investment opportunities, particularly in the dynamic and rapidly growing markets of Asia.

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What is Private Credit? Characteristics and Risks

Private credit refers to loans or debt financing provided by non-bank lenders to companies or individuals. These lenders could include private equity firms, hedge funds, direct lending funds, or other alternative investment vehicles. Unlike traditional bank loans, private credit typically involves direct lending arrangements between the borrower and the lender, bypassing the banking system.

Key characteristics of private credit includes:

• Direct lending: Non-bank lenders give money directly to borrowers.

• Flexibility: Loans can be customised with different terms.

• Diverse borrowers: Small businesses, distressed companies, and others can get loans.

• Higher returns: Investors can earn more, but it's riskier.

And key risks entail:

• Credit risk: Borrowers might not pay back the loans.

• Illiquidity risk: It's tough to sell these loans fast.

• Market risk: Changes in the economy can affect the loans.

• Regulatory risk: Rules might change, affecting investments.

• Operational risk: Issues with managing the loans can arise.

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The Risk to Financial Stability

In addition to general risks, private credit, which entails lending by non-bank financial institutions, can also present threats to financial stability. Here's an overview:

• Leverage: Non-bank lenders often rely on borrowed funds to provide credit, increasing overall leverage in the financial system. This can amplify losses if borrowers’ default or if market conditions worsen.

• Interconnectedness: Private credit providers are often interconnected with other financial institutions. If one lender faces significant losses or liquidity problems, it could spread to others through interconnected financial relationships, potentially leading to broader financial instability.

• Procyclicality: Like traditional banks, non-bank lenders may increase lending during economic upswings when risks seem low. However, this can exacerbate economic downturns if borrowers struggle to repay debts during downturns, leading to a cycle of reduced lending and economic contraction.

• Liquidity Risk: Private credit investments can be illiquid, meaning they are not easily bought or sold. In times of stress, investors may find it difficult to sell these assets quickly, potentially leading to liquidity shortages and fire sales, further destabilising markets.

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Banks are Striking Back

In response to the surge in private credit, banks are intensifying lending activities and diversifying service offerings to compete effectively. They are expanding loan portfolios, emphasising risk management, and offering customised financing solutions to meet evolving borrower needs.

Yet, regulators are closely monitoring the private credit sector and implementing regulations to enhance transparency and oversight. This includes regular assessments to identify emerging risks and vulnerabilities, ensuring appropriate safeguards are in place to mitigate systemic risks.

Overall, while private credit serves as a valuable source of financing for underserved borrowers, its growth warrants vigilant monitoring and regulatory intervention to safeguard financial stability.