Leveraged lending has surged in recent years and risks are rising, yet the full extent of the systemic risk is tough to measure due to gaps in the data, according to the Financial Stability Board (FSB).
The policy group published a report on Thursday examining the implications for global financial stability stemming from the growth in leveraged loans and collateralized loan obligations (CLOs).
Among other things, the report found that the risks have grown since the global financial crisis, as leverage has increased, creditor protection has weakened, and the market’s complexity has ramped up too.
The FSB noted that direct exposures to leveraged loans and CLOs are concentrated among a handful of large global banks, and that there are investment funds and insurance companies that are also exposed to the sector.
“While banks are more resilient to these risks due to higher levels of capital and liquidity as the result of post-crisis reforms, the degree of bank resilience against downturns may be difficult to judge, considering the changes in risk characteristics in leveraged loan and CLO markets,” the report said.
Additionally, the report warned that the full measure of the systemic vulnerabilities is hard to assess due to a lack of comprehensive data on the sector.
“Given data gaps, a comprehensive assessment of the system-wide implications of the exposures of financial institutions to leveraged loans and CLOs is challenging,” the FSB said.
In particular, the report said that “little is known…about the direct exposures of certain non-bank investors to these markets. Including their holdings of lower-rated CLO tranches.”
The FSB pledged to continue monitoring the financial stability risks, and whether it’s possible to close the data gaps.
“Scanning the horizon to identify, assess and address new and emerging risks to global financial stability is at the core of the FSB mandate. This report provides a fact base that authorities and market participants can use to help assess the risks posed by leveraged loan and CLO markets and respond accordingly,” said FSB chair Randal Quarles, governor and vice chairman for supervision at the U.S. Federal Reserve.