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

A risk officer at a regional bank reviews the bank's exposures to the private credit ecosystem. The bank has stopped originating leveraged loans directly but now provides committed back-leverage facilities to private credit funds. Which statement best describes the main way this activity links the bank to private credit risk?

The bank stays exposed indirectly. When it lends to private credit funds, losses in the underlying loans reduce the collateral and resources available to repay the bank's facilities. Seniority and security lower the risk but do not remove it, so private credit stress can transmit back to the bank.

  1. AThe bank has transferred all credit risk to fund investors, so its exposure is limited to the fees it earns
  2. BThe bank remains exposed to private credit losses indirectly because fund losses can erode the collateral and the capacity to repay its facilitiesCorrect
  3. CThe bank's exposure arises only if the private credit fund is itself a regulated bank
  4. DThe bank's exposure is eliminated as long as the facilities are senior and secured, regardless of fund performance

Explanation

Bank lending to private credit funds (back leverage, subscription lines) creates indirect exposure: losses on the underlying loans reduce collateral values and fund resources. Option A ignores that the bank is a lender with credit risk. Option D is wrong because seniority reduces but does not eliminate the risk, which still depends on fund performance.

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