INSIGHTS: The future of finance could be written by private credit not banks

Investor protection, then, is not about stifling the industry but about curbing its weakest practices. In recent years, retail investors have gained increasing exposure to private credit. Although Australia has seen retail participation in credit markets before, history shows it hasn’t always ended well. Poor asset quality, excessive leverage and liquidity pressures drove the collapse of building societies and merchant banks in the 1990s when redemptions surged.

It’s encouraging that the regulator is focused on transparency and accountability for investors without throttling innovation.

“To sustain the vitality of the private credit sector, we need smarter standards – transparent fees, realistic liquidity terms, and differentiated regulation that recognises the industry’s diversity.”

Leverage can be a liability

Many still assume that banks represent the safest and best form of lending. Unfortunately, history says otherwise. Bank crises in 1991 and again in 2008 showed that leverage, not lending, is what brings down institutions.

When banks take excessive risk, taxpayers step in – through deposit guarantees and central bank liquidity – because banks hold the public’s money and sit at the core of the payments system.

While this taxpayer-funded safety net is understandable, it creates a massive market distortion. Banks routinely leverage their balance sheets tenfold, knowing their solvency is backstopped by an implied government guarantee. This effectively subsidises their cost of capital and masks the true risks of their funding costs. It also gives them an advantage over private credit providers who operate without such support.

From the outset, banks and private credit therefore aren’t competing on equal ground, so they should not be regulated the same way. While the report doesn’t seek to equalise them, it should be more explicit in recognising that each plays a different role in the financial system.

Measuring true risk

Risk, moreover, isn’t just about the borrower. It’s also about the relationship between asset risk and the leverage supporting it. The sub-prime mortgage crisis that contributed to the 2008 financial crisis proved this point: it wasn’t just risky borrowers but excessive leverage that caused collapse. True risk equals asset risk multiplied by leverage – not simply the quality of the loan.

Moreover, liabilities are often overlooked in discussions about financial stability. In private credit, leverage is limited, but redemption risk is real. Redemption risk is the danger that a fund cannot meet investor demands to withdraw their money in a timely manner.

When funds offer liquidity mismatched to asset terms, pressure arises precisely when markets tighten and redemptions spike. Liquidity management and honest labelling of redemption terms are vital. Outside leverage, liquidity mismatch is the biggest solvency risk the industry faces.

The report suggests the riskiest part of Australia’s private credit market is real estate construction and development finance.

While that segment carries risk, history tells a bigger story. The 1980s saw bad corporate lending, which caused banks and merchant banks to lose billions. The 1990s then brought a real estate crash, with office values falling about 40 per cent amid soaring interest rates. Even prudent lenders struggled to avoid losses.

This history shows that disciplined lending can still be hit by systemic shocks – something retail investors need to better understand. What matters is the discipline of underwriting, transparency, and proper alignment of risk and reward, whatever the sector.

On the report’s treatment of provisioning, construction lending should never be judged halfway through. As I often say, you don’t eat the cake while it’s still baking.

Interim valuations are meaningless because the building’s value is being assessed in the middle of a project before it is fully completed, sold or generating revenue. The only valuation that matters is when the project is complete.

The report also misses an important distinction: concentrated portfolios, where loans are individually managed, require different approaches than diversified portfolios that use statistical provisioning to build up reserves against expected loan losses over an economic cycle. Australia also needs stronger specialist credit-rating capability if the industry is to mature.

Transparency matters

One of the most important parts of the Williams-Timbs report concerns fees. The question isn’t whether managers should be paid for their work – of course they should. The question is whether those fees are transparent and aligned with investor interests. Borrower-paid fees and margins vary widely across funds. There’s nothing wrong with sharing in upfront borrower fees – provided it’s capped and disclosed. The problem arises when arrangements are hidden or inconsistent.

Some of this stems from ASIC’s Regulatory Guide 97 (RG 97), which governs how funds, including super funds, disclose fees and costs to retail investors. Designed for transparency, it has made it difficult for funds to pay private credit managers fairly for the labour-intensive work of origination, monitoring and restructuring.

The solution isn’t to demonise them but to modernise the rules. Regulators should clarify how super funds can legitimately pay for credit expertise without distorting the appearance of low fees. Otherwise, the market will drift toward misleading ‘low-fee’ models that hide true costs and misalign incentives.

The interim report gets many things right: transparency, liquidity management, and consistent terminology. But it understates how low fund-level leverage makes private credit more stable than banks, and it does not fully differentiate between institutional and retail segments.

A more detailed report due in November will no doubt expand on these themes and address some of the concerns that have been raised.

To sustain the vitality of the private credit sector, we need smarter standards – transparent fees, realistic liquidity terms, and differentiated regulation that recognises the industry’s diversity. If we get that balance right, private credit can protect inexperienced investors, empower professionals, and strengthen the real economy – without taxpayer backing. That’s a goal worth pursuing.