Private Debt and the Problem of Institutional Capacity

The expansion of private debt across Latin America and in Mexico is one of the most significant phenomena and, at the same time, one of the least critically examined, in the recent evolution of the national financial system. In the prevailing discourse on corporate financing, private debt is often presented as an efficient response to the structural limitations of traditional bank credit, a flexible tool capable of channelling capital to companies and projects that, due to their risk profile, size or complexity, do not fit into the regulated financial system.

However, this functional narrative, focused almost exclusively on the operational efficiency, speed of execution and contractual adaptability of private debt, has tended to relegate to the background the legal, institutional and systemic implications that accompany its rapid growth. The result is a market that is expanding rapidly, but whose institutional architecture remains incomplete and, in certain respects, fragile.

Private debt, understood as financing provided by non-banking financial institutions within the framework of private capital, should not be conceived as a simple variant of traditional credit, but rather as a qualitative transformation in the way credit risk is conceived and managed.

While the banking system is structured around a logic of regulated intermediation, in which risk is mitigated through prudential requirements, reserves, continuous supervision and uniform origination standards, private debt is fundamentally based on individualised contractual relationships. In this model, risk management shifts from the institutional to the private sphere, relying on the autonomy of will, the sophistication of the parties, and legal structuring as central mechanisms of protection. This shift, although functional from the perspective of flexibility, introduces significant tensions when analysed from a systemic and long-term perspective.

The Role of Private Equity in Private Debt

The growth of private debt in Mexico cannot be understood without considering the development of private equity as an asset class. As private equity funds have consolidated their presence in the country, their investment strategy has evolved from a predominantly capital-focused approach to more diversified schemes that include direct debt, mezzanine debt, structured financing and hybrid mechanisms that combine debt and equity characteristics.

This evolution responds both to macroeconomic factors, such as financial market volatility, interest rate cycles and the need to offer more stable returns to institutional investors, as well as to strategic considerations related to control, payment priority and mitigation of the risk of total loss of invested capital. In this context, private debt not only fulfils a financial function, but also a function of economic control and corporate discipline.

In the case of Mexico, the private capital ecosystem has grown rapidly over the last two decades, driven by financial developments, relative macroeconomic stability and the growing participation of domestic and international institutional investors. This growth has been accompanied by greater sophistication in investment structures and the adoption of contractual practices imported from more developed markets, a process that has been driven and articulated by organisations such as the Mexican Private Equity Association, among other actors.

However, the institutional implementation process has been incomplete. Many of the private debt structures operating in Mexico replicate models designed for legal and financial systems with greater institutional capacity, without necessarily having the local conditions for their proper implementation and execution.

Private Debt in Mexico

One of the structural factors explaining the expansion of private debt in Mexico is the configuration of the banking system itself. Commercial banks operate under a strict prudential framework, supervised by the National Banking and Securities Commission, which prioritises financial stability over credit expansion.

This approach has contributed to the soundness of the Mexican banking system, but it has also led to the systematic exclusion of medium-sized companies, projects in the development stage and non-standard legal structures. In this systemic gap, private debt has emerged as a partial substitute for credit, filling spaces that banks cannot or are unwilling to cover.

However, the substitution of bank credit with private debt is not neutral from an economic or institutional point of view. Banks, as regulated financial intermediaries, internalise certain systemic costs through capital requirements, provisions and risk concentration limits, costs that serve a stabilising function.

Private debt, in contrast, externalises much of these costs to market participants themselves, relying on investor sophistication, portfolio diversification and contract strength as sufficient risk mitigation mechanisms. This logic may be functional in contexts of economic growth and financial stability, but it becomes particularly fragile in stress scenarios, where the correlation between risks increases and assumptions of independence from default events cease to be valid.

Added to this scenario is a structural excess of private capital in search of returns. In an environment characterised by compressed yields on traditional assets and volatility in public markets, investors have shown a growing willingness to take on additional risk in exchange for higher returns. Private debt offers an attractive narrative, recurring income, priority of payment over equity, and apparent protection through enhanced guarantees and contractual rights. However, this narrative tends to underestimate the real complexity of credit risk and overestimate the effectiveness of contractual protections, particularly in a legal environment where enforcement faces structural obstacles.

Challenges of Private Debt

A central and often underestimated element of the private debt problem in Mexico is that, even though this market is presented as an alternative to the limitations of bank credit, a considerable proportion of Mexican companies lack the institutional capacity necessary to access it on reasonable terms. Unlike more developed markets, where private debt tends to be channelled to companies with consolidated corporate structures, standardised financial processes and a robust compliance culture, in Mexico a significant part of the business fabric operates with limited levels of institutionalisation.

This institutional weakness manifests itself, among other things, in the absence of consistently audited financial statements, the fragility of corporate governance systems, the informality of internal processes and the concentration of decision-making in one or a few individuals, factors that together constitute structural barriers to effective access to the private debt market.

This lack of institutional capacity has a contradictory effect. On the one hand, companies that manage to access private debt often do so by accepting particularly onerous contractual structures, with high rates, extensive guarantees and enhanced control rights for the creditor, precisely as compensation for the borrower’s institutional weaknesses. On the other hand, a large number of companies are completely excluded from the private debt market, not because they lack economically viable projects, but because they do not meet the minimum formal or informal standards that funds require to justify their investment. In this sense, private debt not only reproduces but, in some cases, deepens structural inequalities in access to financing.

Furthermore, the limited institutional capacity of many borrowers increases the operational risk of private debt. Weak financial reporting systems, the absence of robust internal controls and excessive reliance on personal management hinder effective credit monitoring and reduce the practical usefulness of financial agreements. In these cases, contractual mechanisms designed to anticipate risks lose their effectiveness, forcing the creditor to resort early to corrective measures or the enforcement of guarantees, which deteriorates the economic value of the transaction and the relationship between the parties. Private debt, conceived as a risk mitigation tool, can thus become a factor in amplifying pre-existing vulnerabilities.

Legal Opportunities

From a legal perspective, the development of private debt in Mexico relies heavily on the intensive use of guarantee, administration and payment source trusts. These instruments allow for asset segregation, direct control of cash flows, and the implementation of priority schemes that seek to replicate and even exceed the protections of bank credit. However, the formal sophistication of these structures contrasts with the reality of their execution. The judicial interpretation of trusts, the co-existence of multiple creditors with different priority ranks, the lack of consolidated jurisprudential criteria and the limited specialisation of the courts generate uncertainty about the actual recoverability of credits in default scenarios.

Private debt contractual structures tend to reflect a logic of maximising protection for the creditor, incorporating high interest rates, prepayment penalties and broad early maturity scenarios. Although these conditions are justified by the higher risk assumed, in practice they can create a vicious circle in which the financial cost increases the probability of default and triggers contractual mechanisms that aggravate the borrower’s situation. This rigidity is particularly problematic in contexts of economic slowdown, where the lack of flexibility limits the capacity for adaptation and renegotiation, increasing the probability of suboptimal outcomes for both parties.

Economic Considerations

An analysis of private debt from a macroeconomic perspective reveals that its growth can no longer be understood solely as an isolated or strictly contractual phenomenon. Although this type of financing takes place outside the regulated financial system, its expansion has given rise to a growing network of interdependencies with systemically important actors.

The increasing participation of pension funds, insurers and other institutional investors in private debt vehicles introduces indirect channels of risk transmission that, in adverse scenarios, can amplify the effects of credit defaults. In the absence of loss absorption mechanisms comparable to those in the banking system, these adjustments tend to be passed on directly to investment portfolios, increasing volatility and reducing room for manoeuvre in the face of macroeconomic shocks.

This phenomenon is part of the broader debate on non-banking financial intermediation and so-called shadow banking. Although private debt does not fully fit into this category, it shares with it the assumption of credit risks outside the regulatory perimeter and the reliance on private contractual mechanisms for risk management. The misalignment of incentives in credit origination and management, particularly when portfolio growth is prioritised over credit quality, is an additional source of vulnerability.

Mexico Versus Other Markets

From a comparative perspective, it is clear that the development of private debt in Mexico has followed a different trajectory from that observed in markets with greater institutional depth. In the latter, contractual flexibility is offset by predictable legal frameworks, specialised courts and efficient dispute resolution mechanisms. In Mexico, the gap between contractual design and practical execution introduces an additional degree of uncertainty that affects both creditor and borrowers, raising the cost of financing and limiting its long-term sustainability.

The role of financial authorities in this context is necessarily ambivalent. Although private debt falls outside the traditional scope of supervision, the growth of non-bank financial intermediation has led institutions such as the Bank of Mexico to monitor the risks associated with these segments more closely. However, the variety of investment vehicles and the lack of standardised information make it difficult to develop accurate and timely diagnoses.

The regulatory dilemma posed by private debt does not admit simple solutions. Excessive regulation could inhibit financial innovation and restrict access to credit for segments that depend on this type of financing, while the total absence of minimum standards perpetuates current weaknesses. The challenge is to move toward a proportional framework that strengthens governance, transparency and market discipline without distorting the flexibility that has enabled the growth of private debt.

Ultimately, the sustainability of the private debt market in Mexico will depend on its ability to evolve from a predominantly contractual model to a more institutionalised one. This implies greater professionalisation of administrators, a clearer separation of critical functions, a more conservative assessment of credit risk and a realistic understanding of the limitations of the legal framework. Private debt cannot and should not serve as a full substitute for bank credit, but rather as a complement that fulfils a specific function within the financial ecosystem.

Conclusions

The problem with private debt in Mexico does not lie in the existence of this instrument, but in the institutional conditions under which it has grown. Private debt has filled a real gap in business financing, but it has done so by transferring significant risks to the contractual sphere and relying on an institutional architecture that is still in the process of consolidation. The challenge for the Mexican financial system is to recognise the relevance of private debt, understand its limits, and promote its evolution toward a more transparent, disciplined and legally sound market capable of contributing to economic development without compromising financial stability.

The challenge for the Mexican financial system therefore lies in recognising the relevance of private debt as a structural component of corporate finance, clearly understanding its limits, and promoting its evolution toward a more transparent, disciplined and legally robust market. This requires not only improved contractual practices and stronger governance standards, but also a more realistic assessment of the conditions under which private debt can contribute sustainably to economic development without becoming an additional source of vulnerability for financial stability.

The silver lining is that only two aspects of private debt can provide for its progression and growth in developing markets like Mexico and, broadly, in Latin America, accelerating impact in the financial sector.

• Legal structures – solid legal structures allow for better and more efficient risk management. Recent history and experience has shown that transactions that are correctly structured have outperformed other transactions when recovering credit. This is achieved with solid sources of payment and properly structured guarantees.
• Risk assessment – due diligence processes are important to correctly assess risk in private credit transactions. Local counsel can provide valuable information on the good standing of debtors, including any sources of payment and guarantees. Continuous oversight is necessary to evaluate any changes in risk during the different stages of financing.

Companies must understand the growth potential that can be achieved with private debt structures in developing markets and start shifting towards having better governance and institutionalisation to access sound private debt. In addition, financial participants, including regulating authorities, jurisdictional authorities, banks, non-banking financial institutions and funds, each should encourage clear propositions from their sectors to promote responsible private debt mechanisms.