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Risky Loan Market Draws Scrutiny From Financial Stability Board

The FSB is worried about potential “financial stability risks” posed by leveraged loans – risky debt that helps fund buyouts.

The Financial Stability Board is taking a hard look at risky corporate debt.

Over the coming months the board will be “evaluating the global pattern of exposures to collateralized loan obligations and leveraged loans, so as to improve understanding of the global financial stability risks that these may entail,” according to a letter from Financial Stability Board chair Randal Quarles to G20 finance ministers and central bank governors. Quarles sent the letter ahead of the board’s planned April 11-12 meeting in Washington, the FSB said Tuesday.

The FSB has entered a “new phase” focused on emerging vulnerabilities, a shift in priorities after developing regulatory reform in the years following 2008 crisis, according to Quarles, who is a Federal Reserve governor serving as the central bank’s vice chair for supervision. He expressed concern that “downside risks” to global growth and elevated debt levels are increasing.

“Loosening lending standards, elevated asset values, and high corporate and public debt call for particular vigilance,” Quarles said in the letter. 

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Investors have been hunting for yield in riskier assets over the past decade, including within the leveraged loan market. For example, covenant-lite loans, which lack safeguards designed to protect lenders, have become prevalent since the crisis, and are particularly popular among companies backed by private equity firms.

In the letter, Quarles said the FSB would assess the implications of non-bank lending, which has grown since the crisis as asset managers have stepped up lending activity.

“The growth in non-bank financing represents a welcome increase in the diversity of the sources of finance supporting economic activity, provided that such financing is resilient,” Quarles said in the letter. The FSB continues to “monitor closely the developments and risks in non-bank financial intermediation,” he said. 

The FSB chair has a background in alternative investing. Before becoming a Fed board member, Quarles was a managing director at Cynosure Group, a Salt Lake City-based alternative asset manager that he co-founded in 2014. He had previously worked as a partner at Carlyle Group, a large private equity firm based in Washington. 

JPMorgan Chase & Co. CEO Jamie Dimon warned last week in his annual letter to shareholders that shadow banking needed more regulatory attention as lending beyond Wall Street has risen over the past decade.

Dimon also said that leveraged lending is “a growing issue” but added that JPMorgan doesn’t yet see it causing systemic problems in the financial system.

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