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

A risk manager compares a bank's leveraged loan book with a private credit fund's direct lending book. Both hold similar middle-market borrowers. Which statement best describes a key difference in the liquidity and funding risk profile of the two?

Banks fund illiquid loans with deposits and short-term wholesale funding, creating run and maturity transformation risk but with central bank backstops. Closed-end private credit funds use locked-up investor capital, which reduces forced selling, though leverage and semi-liquid vehicles can add liquidity risk.

  1. AThe bank has stable long-term funding, while the private credit fund relies on overnight deposits
  2. BThe bank funds with runnable deposits and wholesale funding with a liquidity backstop, while a closed-end private credit fund has locked-up capital that limits forced sellingCorrect
  3. CBoth face identical run risk because both fund with demandable liabilities
  4. DThe private credit fund has greater maturity transformation risk because investors can redeem daily

Explanation

Banks fund with deposits and short-term wholesale liabilities and have central bank access, creating maturity transformation and run risk. Closed-end private credit funds have locked-up capital with long-dated commitments, so forced asset sales are less likely. The other options misstate funding structures.

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