As India strives to become a $5-trillion economy in the near future, an often overlooked yet powerful force is reshaping its financial landscape: the rise of private credit. Traditionally, India’s credit market has been dominated by banks and non-banking financial companies (NBFCs).
However, private credit — non-bank lending facilitated by specialised credit funds — is emerging as a vital catalyst for growth. Unlike traditional bank loans, which come with rigid terms, private credit offers customised solutions tailored to borrowers’ specific needs. This flexibility is particularly crucial for sectors like infrastructure and real estate, where large-scale, long-term funding is essential but not always available through conventional channels.
However, the Reserve Bank of India (RBI) has expressed concerns about the rapid growth of private credit, warning that the increasing interconnectedness between banks and non-banks could pose systemic risks. Let’s map the evolution of private credit and its challenges.
Private credit and flexibility
Private credit refers to non-bank lending where funds are provided by private institutions rather than traditional banks.
This type of credit typically involves direct lending to companies, allowing for more tailored and flexible financing solutions.
This adaptability makes private credit especially attractive to mid-sized companies and capital-intensive sectors like infrastructure, real estate, and manufacturing — industries that require substantial investment, often beyond the reach of conventional funding sources.
In India, private credit investments are structured under Category II of the Alternative Investment Funds (AIFs) regulations. These funds offer a variety of financing solutions, from providing credit to distressed debt, special situations, and venture debt.
Surge in private credit
In the first half of 2023 alone, private credit investments surged to $5.1 billion across 63 deals, with an average deal size of $80 million. This represents a compound annual growth rate (CAGR) of 28 per cent since 2018.
A significant driver of this growth is the underdevelopment of India’s corporate bond market, particularly for lower-rated bonds. This gap has pushed businesses to seek alternatives, making private credit a crucial source of funding, particularly for firms that would otherwise struggle to secure financing in the traditional bond market.
Managing risks
One of the key strategies that private credit funds use to manage risk and reduce defaults is the implementation of tight covenants. Covenants are conditions in loan agreements that require borrowers to meet specific financial metrics and operational milestones. These conditions serve as early warning systems, allowing lenders to identify potential issues before they escalate into defaults.
Tight covenants typically include requirements such as maintaining minimum cash reserves, adhering to specific debt-to-equity ratios, and achieving revenue targets. This proactive approach protects the lender’s capital and helps borrowers stay on track financially.
HNIs and pvt credit
High-net-worth individuals (HNIs) are increasingly turning to private credit, driven by changes in debt taxation and a need for better returns. Investing in AAA or AA bonds in India typically yields spreads of 0.5 per cent to 1 per cent over government bonds.
However, when moving down the credit spectrum, the differential — or spread — over government bonds can increase dramatically, ranging from 4 per cent to as much as 8 per cent.
Recent changes have made the tax burden on debt mutual funds more pronounced, reducing post-tax returns and prompting HNIs to seek alternatives. Private credit funds offer a compelling solution, typically providing higher yields than traditional debt funds.
India in the global market
The size of the private credit market at the start of 2024 was approximately $1.5 trillion, compared to approximately $1 trillion in 2020, and is estimated to grow to $2.8 trillion by 2028.
In 2024, India’s private credit AUM stood at around $15 billion, but this is expected to soar to between $60 and $70 billion by 2028.
This rapid growth underscores the increasing importance of private credit in India and signals its potential to become a global powerhouse in this sector.
This growth is driven by strong economic fundamentals, a burgeoning middle class, and an insatiable demand for infrastructure development.
Navigating Challenges
Despite its bright prospects, the private credit market in India is not without challenges. The regulatory environment, though improving, still presents significant hurdles. The Insolvency and Bankruptcy Code (IBC), a critical tool for resolving distressed assets, has seen its average resolution times balloon to over 700 days — well above the stipulated period.
These delays undermine investor confidence and make the private market less appealing, particularly for those interested in distressed debt and special situations.
RBI in its latest financial stability report propagated risks in private credit markets can occur through several key dimensions: (i) riskier borrowers compared to traditional lending, potentially leading to significant losses; (ii) systemic risks for investors, especially insurance companies and pension funds, due to large capital losses; (iii) increasing complexity in private credit structures, with multiple layers of leverage; (iv) heightened liquidity risks from the growing retail presence and increased redemption rights; and (v) greater interconnectedness with other financial system segments.
Banks, insurers, and pension funds are expanding their involvement in private credit, with private equity firms also increasing stakes in life insurance companies.
However, data gaps hinder effective monitoring, and private credit’s resilience remains untested in a credit downturn, posing the risk of sharp losses and a potential loss of confidence in the asset class.
The writer is Professor of Finance – IMT Ghaziabad