Evolving Private Credit
Rapid growth, expanding leverage, and deeper financial linkages are changing the industry's risk profile
In recent months much has been written regarding the rapid growth of private credit (PC) and related risks incubating within the financial system. This concern has been intensified by the surprise failures of private credit borrowers and subsequent investor runs on private credit firms.
While the industry does not appear to pose an immediate systemic risk to the financial system, its rapid growth, expanding leverage, and complex ties within the financial industry deserve attention before private credit becomes the unexpected force that undermines the financial system.
Private credit
In its simplest form, private credit is direct lending by nonbank institutions, business development companies (BDCs), or other asset managers to highly leveraged companies. The loans are not publicly issued bonds and are usually not traded in liquid public markets. They are privately negotiated, often senior secured, floating-rate, and commonly held until maturity or refinancing.
The private credit borrower is typically a middle-market company: too large or complex for ordinary small-business lending, but too leveraged or too opaque for traditional bank lending or the public bond market. Some are backed by private equity sponsors.
Private credit funds are ready lenders because they can offer borrowers greater speed, flexibility, certainty of execution, and confidentiality. Given these advantages, it isn’t surprising that private credit funds have experienced extraordinary growth in recent years.
The Federal Reserve estimated in 2024 that the U.S. total private credit market had reached nearly $1.7 trillion, making it comparable in size to the leveraged loan and high-yield bond markets. Using slightly different definitions and a broader global perspective, the Bank for International Settlements (BIS) and the Financial Stability Board (FSB) estimate that private credit fund assets under management have grown from about $2 billion in the early 2000s to between $2.0 and $2.5 trillion today.
While estimates vary, the conclusion is the same: Private credit has evolved from a niche financing source into an increasingly important component of corporate credit markets.
Factors behind private credit’s growth
Several factors have contributed to this growth. First, as the banking industry argues, the post-Great Financial Crisis capital and liquidity requirements made some forms of leveraged corporate lending less attractive for commercial banks. Second, the prolonged low-interest-rate period after 2008 encouraged qualified investors to seek higher-yielding alternatives to public bonds, and private credit helped meet that demand. Finally, borrowers value the private credit model. Companies can obtain tailored financing packages more quickly from a small group of direct lenders than through a public syndication or a more cautious commercial bank.
How are private credit firms funded?
On the supply side, private credit firms are funded with long-term investor capital. Sources include, for example, pension funds, insurers, sovereign wealth funds, endowments, private funds, family offices, and high-net-worth individuals. These sources — the limited partners — commit capital to a fund for multiple years, and managers draw on that capital as loans are originated, thus protecting the fund from unexpected short-term liquidity events.[1] Thus, the growth in the supply of capital through private credit and the explosive demand for leveraged capital among mid-tier firms to fund acquisitions, refinancings, and balance sheet growth has made this market a mainstay in corporate finance.
Unlike banks, however, private credit funds have no access to insured deposits or to central bank liquidity facilities. Consequently, to maintain investor confidence, they historically have operated with far less leverage than do commercial banks. The IMF reports that the typical private credit fund has maintained debt-to-equity ratios ranging from roughly 0 to 1.3 times, while BDCs often operate around 0.8 to 1.2 times. In contrast, the commercial banking industry, which benefits from both deposit insurance and central bank liquidity, operates with total debt-to-equity ratios averaging 10 to 1.
Thus, while both commercial banks and private credit funds are corporate lenders, they cover their risks in very different ways.
Also, while private credit may compete with banks in the direct lending arena, it is at times an attractive loan market for banks. When banks lend to private credit, they may mitigate risks that come when lending directly to the private credit borrower. Banks commonly lend to private credit using secured credit or senior tranches, which enables them to diversify across portfolios, capital-call rights, or overcollateralization. The Federal Reserve Bank of Kansas City, for example, found that bank loans to private credit funds had lower predicted default rates than ordinary commercial and industrial loans. As a result, these loans carried lower risk-weighted capital requirements while generating risk-adjusted returns as high as 30%.
In summary, the private credit industry provides several benefits to credit markets. For borrowing companies, it supplies capital when banks or public markets are unavailable, slow to respond, or unwilling to lend. It finances acquisitions, firm expansions, refinancings, working capital needs, and a variety of asset-based projects. The bilateral relationship between lender and borrower can make workouts easier because lenders can amend terms faster than a dispersed bondholder base.
For investors, private credit provides higher returns than they receive from other investment options. And for the economy more broadly, private credit diversifies the supply of credit, making middle-market firms less dependent on traditional banks to meet their liquidity needs and support their operational growth.
Private credit’s changing structure
While the industry’s success is noteworthy, market conditions are changing. Interest rates are higher, the economy is less certain, investors are more cautious and, thus, maintaining its funding base has become more difficult. Accordingly, the industry has been modifying its operating framework, adding leverage, seeking new funding sources, and shortening its liability structure. Simply stated, it is increasing its overall risk profile.
More leverage, more complexity
For starters, private credit funds have increased their reliance on leverage. BDCs, for example, which had been subject to debt-to-equity limits of 1:1, have seen those limits increased to 2:1. Private credit funds also have added a host of debt vehicles to their sources of funding. These include bank subscription lines of credit backed by investor commitments, facilities backed by loan portfolios, net-asset-value (NAV) commitments, asset-backed lending, repo-style financing, and private credit collateralized loan obligations (CLOs).
As the use of these instruments has grown, the BIS estimates that private credit leverage has risen from about 0.4 times debt-to-equity in 2011 to more than 1.0 times on average in 2024. Some recent estimates place private credit CLO debt-to-equity ratios as high as 6 to 1.
As private credit employs more leverage to fund an already highly leveraged borrower, its vulnerability to an economic shock increases accordingly. The FSB reports that private credit borrowers are often rated around single-B credit quality and that external estimates place borrower leverage at five to six times debt-to-EBITDA, compared with roughly four times for leveraged loans. Also, because some accounting adjustments can make leverage appear lower than its economic reality, the FSB noted that “true” leverage in some private credit deals is closer to seven times debt-to-EBITDA.
Growing interconnections and conflicts
A further change within the industry beyond the level of leverage is its context. Private credit firms are affiliated with some of the largest private equity (PE) funds searching for convenient sources of funds for their subsidiary operations. For example, The Wall Street Journal reports that PE-owned insurance companies are investing policyholders’ money in private credit products sold by parent firms or affiliated interests. Examples of asset managers entering this realm include Apollo and Brookfield. Volume estimates of inter-affiliate funding arrangements show a sizable increase, from hundreds of millions in 2002 to billions of dollars today.
Embedded within such arrangements are inherent conflicts of interest that pose unique risks. If banking history is any indication, for example, inter-affiliate transactions function smoothly during economic growth years, but in periods of economic contraction, they are often abused as liquidity is sought from the well-funded to the cash-starved affiliates.
Expanding access to retail capital
Finally, the private credit industry is seeking to broaden its source of funding by gaining greater access to retail investors, including through 401K retirement plans. Proponents argue that such access would allow retail investors to participate in potentially higher-return investments. The assumption is that plan trustees can make sound investment choices among competing PC funds.
Nevertheless, the more private credit funds become embedded in retail-oriented institutions, the greater the pressure will be to bail out retail investors and by extension private credit investors more broadly should a financial crisis occur and the most highly levered transaction suddenly unwind.
Risks going forward
Currently, despite its growth and recent problems, the private credit industry does not appear to pose a systemic risk to the broader financial industry. Moody’s reported, for example, that as of June 2025, U.S. banks had approximately $300 billion in loans outstanding to private credit providers, about $285 billion to private equity funds, and roughly $340 billion in unused lending commitments to those borrowers. In total, this represents only about 3% of U.S. commercial banks’ assets. Its footprint to other sectors also remains relatively modest.
Early warning signs
Still, the private credit industry is showing signs of strain. The failures of First Brands and Tricolor in 2025 shook confidence by exposing weaknesses in underwriting, collateral controls, and transparency. In addition, the opacity of PC balance sheets and the resulting uncertainty regarding asset quality have triggered investor outflows and weakened investor confidence.
These outflows were not bank runs in the classic deposit-funded sense. Private credit firms have locked up capital and repurchase limits designed to prevent forced sales of illiquid loans. Nevertheless, the borrower failures and subsequent market reaction illustrate the semi-liquid nature of private credit products and the market friction that can follow a loss of investor confidence. Firms as large as BlackRock and Morgan Stanley, for example, found it necessary to restrict withdrawals after redemption requests rose, in one case reaching nearly 11% of shares outstanding.
Such events serve as a warning
While private credit is a useful source of capital for mid-tier and higher-leveraged borrowers, the related risks and shortcomings are real. The industry has grown exceptionally fast, and it is employing greater leverage and adding complexity to its balance sheet. The industry also is known to employ payment-in-kind features within its loan portfolio to keep loans out of the nonperforming designation. At the same time, however, its balance-sheet reporting is opaque, and asset valuations are subject to management bias. At a minimum, such practices justify the call for greater balance sheet transparency and better reporting on inter-affiliate transactions.
Finally, while the private credit industry’s risk profile appears manageable, that assessment may change as private credit grows in scale and scope. Experience should remind both the industry and policymakers that innovative entrants into finance seldom start as immediate sources of systemic risk. As private credit expands, leverage increases, and access to retail and related institutional funding broadens, its systemic risk profile will increase, perhaps significantly.
Thus, the financial system would benefit if policy demanded clearer accounting standards and reporting guardrails regarding capital and leverage, and greater transparency surrounding inter-affiliate transactions. It is a matter of time before the next financial crisis arrives, and appropriate guardrails could help prevent private credit from becoming its source.
Sources used include: Jordan Pandolfo, “Banks and Private Credit: Competitors or Partners?” Federal Reserve Bank of Kansas City, Economic Bulletin, March 2025. Fernando Avalos, et. al., “the global drivers of private credit”, BIS Quarterly Review, March 2025. “Report on Vulnerabilities in Private Credit”, Financial Stability Board, May 2025. “Private Credit Fault Lines”, Thoughts from the Frontline, November 2025. Pete Vatev, “Private Credit’s Surge Has Investors Excited and Regulators Concerned”, Enterprising Investor, CFA Institute, June 2025. Cai, Fang and Haque, Sharjil, “Private Credit: Characteristics and Risks” Federal Reserve Board, February 2024. Berg, Jeffrey, et al., “US banks’ private credit loan exposure nears $300 billion”, “Banks fund the competition: The rise and risk of lending to non-bank lenders” Moody’s, October 2025.
[1] However, this is changing as BDCs and interval-style funds have introduced various liquidity features designed to attract retail investors.