Australia needs better credit investing, not less of it

The conversation around credit investing has changed.

The collapse of Bathla has sharpened scrutiny of private credit and non-bank lending in Australia. That scrutiny is justified. When a large borrower fails, investors rightly ask questions about underwriting, valuation, security, concentration, governance, liquidity and whether they had enough visibility of the risks being taken on their behalf.

Bathla should not be dismissed as an isolated event. Nor should it lead to the conclusion that Australia needs less non-bank credit. The more useful conclusion is that Australia needs better credit investing.

Banks remain fundamental to Australia’s financial system. But they cannot, and should not be expected to, provide every form of finance needed by households, small businesses, property projects and established companies. A resilient credit market needs more than one source of capital. It also needs each source to operate with high standards of underwriting, governance, disclosure and risk management.

More than a bank funding gap

The role of non-bank lenders is often oversimplified. If a bank does not provide finance, it does not necessarily mean the borrower is uncreditworthy.

Banks operate within regulatory capital requirements, portfolio limits, standardised lending policies and changing sector risk appetites. These constraints are important. They protect depositors and support financial-system stability. But they can also mean viable borrowers fall outside a bank’s preferred lending parameters.

A business may have strong assets, experienced management and a credible repayment strategy, but require a structure that does not fit a traditional bank model. A borrower may need speed, a bespoke facility or funding at a scale that does not suit a bank’s current appetite. A project may be sound on its individual merits while sitting in a sector where banks have reduced their exposure.

Non-bank lenders can help meet these needs by specialising in particular asset classes, assessing transactions individually and structuring finance around borrower circumstances. The Reserve Bank has recognised that non-bank lenders can support economic activity that might otherwise go unfunded by traditional banks.

This does not mean non-bank lenders should take more risk or lend more freely. It means they must be capable of assessing risk properly, structuring loans conservatively and acting decisively when conditions change.

The Bathla test

Private credit is not a homogenous asset class. The quality of an investment depends on the borrower, the purpose of the loan, the security supporting it, the lender’s position in the capital structure, the quality of the underwriting and the discipline of ongoing monitoring. It also depends on the investment structure around the loan.

Investors should understand exposure to individual borrowers, sectors and managers, whether approval and valuation processes are independent, and whether withdrawal terms are realistic for the liquidity of the underlying assets. A portfolio of bespoke, long-dated loans does not become genuinely liquid simply because investors are offered frequent redemptions.

ASIC has recently highlighted variation in private-credit risk-management practices, including disclosure, valuation, governance and liquidity management. It has also recognised that credit investing can play an important role in the economy, provided standards improve as the market grows.

That is the right benchmark. The response to recent events should not be a retreat into broad claims about asset-class resilience. It should be greater discipline, transparency and evidence that risks are understood and actively managed.

Income, with eyes open

Credit investing became more relevant as investors looked beyond traditional cash products and term deposits, particularly when the low-interest-rate environment reduced income from those assets.

However, credit investments are not a simple substitute for cash or deposits.

Term deposits are relatively straightforward, transparent and, within relevant limits, protected by the Financial Claims Scheme. Credit investments carry different risks, including borrower default, security-value movements, illiquidity, valuation uncertainty, refinancing risk, concentration and manager capability.

The important question is not which product offers the highest headline rate. It is whether the expected return adequately compensates investors for the risks involved.

A carefully constructed credit allocation may provide contractual income, potential floating-rate exposure and diversification from listed equity and traditional fixed income. But those benefits depend on portfolio construction and manager selection. They should not be assumed from an asset-class label alone.

Better standards lead to stronger markets

A broad contraction in credit availability can be damaging for the economy. When lenders simultaneously become more cautious, businesses may delay investment, projects may stall and otherwise viable borrowers can struggle to refinance. The results can be a self-reinforcing cycle, where reduced credit availability weakens economic activity and, in turn, causes lenders to become even more cautious.

Australia needs a competitive and diversified credit market. Non-bank lenders are not a substitute for banks. They are a complementary source of capital that can reduce reliance on a single lending channel.

But diversification only strengthens the system when it is supported by high standards.

Credit risk cannot be eliminated. What investors should expect is a manager that identifies risk early, manages it actively and communicates openly when circumstances change.

Australia needs more than banks to keep credit flowing. The future of credit investing will depend on whether the industry earns and maintains investor confidence through better practice.

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