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FRM Part II · FRM Exam Part II · The Rise and Risks of Private Credit

A risk manager at a pension fund compares a private credit fund holding senior direct loans with a bank that holds similar loans funded by deposits. Which statement best describes the key difference in how liquidity risk is structured?

The bank funds illiquid loans with demandable deposits and so faces run risk through maturity transformation. A closed-end private credit fund locks up long-term investor capital with limited redemption rights, which lowers fund-level run risk, although leverage and semi-liquid structures can partly reintroduce liquidity risk.

  1. AThe bank has stable funding that can run, whereas the closed-end private credit fund has long-term capital with limited redemption, reducing run risk at the fund levelCorrect
  2. BBoth rely on demandable deposits, so they have identical run vulnerabilities
  3. CThe private credit fund has greater maturity transformation than the bank because investors can withdraw daily
  4. DThe bank has no liquidity risk because deposits are insured, while the fund has no liquidity risk because loans are floating rate

Explanation

Banks fund illiquid loans with short-term, demandable deposits, creating maturity transformation and run risk. Closed-end private credit vehicles lock up investor capital for years, so fund-level run risk is lower, though leverage, credit lines and semi-liquid structures can reintroduce liquidity risk. The other options misstate the funding structures.

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