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Regulators fret over hidden risks as tentacles of private credit reach deep into banks
by Lisa Fu
One lesson of the 2008 financial crisis is that regulators were late to grasp the risks lurking in an explosion of collateralised mortgage lending. They are determined not to make the same mistake with private credit.
Regulators around the world are taking a magnifying glass to private credit as banks, insurance companies and various investment platforms become increasingly entangled with this once-niche asset class.
“One scenario in which there could be losses for the banking system would be if there were particularly severe or prolonged defaults in the end companies that borrow from private credit funds,” said John Levin, senior markets specialist in the supervision, regulation and credit department at the Federal Reserve Bank of Boston, in an August podcast.
Lending to private credit-related investment vehicles is growing fast. Committed credit lines by the largest US banks to private debt funds and business development companies increased by 145% over the past five years to USD 95bn at the end of 2024, according to a May report from the Federal Reserve.
That is still a small share of the private credit asset class, which surpassed USD 3tn in global assets under management in 2024, according to the Alternative Credit Council. But regulators are particularly alert to the risk that layer upon layer of leverage could amplify the financial damage inflicted by a recession or a jump in interest rates.
Loans to non-bank entities such as private credit managers now exceed 10% of total loans in the US banking system as banks reduce lending to their own customers in favour of “lending to lenders”, according to a May report from Barclays.
Total US bank lending to private debt vehicles ($bn)
Source: US Federal Reserve
In June, the European Central Bank wrote that exposures to private equity and private credit can be deceptive: “What might appear as a straightforward asset-backed loan can turn out to be a complex set of related exposures that share underlying risk drivers and vulnerabilities, particularly when banks are financing several levels along the investment chain.”
Banks in both the US and Europe often lend to institutional investors that become limited partners in a private credit fund. They may also provide debt at the fund level in the form of subscription lines and net-asset-value loans, and they may co-underwrite loans with private credit managers.
Private credit managers and other non-bank financial institutions increasingly lend not only to sub-investment grade portfolio companies, but also to private funds and other lenders.
Private credit managers may buy into insurance companies and manage those insurers’ investments. They team up with banks to originate loans, but also borrow from the same banks to add leverage to their investment funds. No wonder regulators are struggling to keep up.
“The need for sophisticated risk management frameworks and enhanced supervisory oversight has become paramount to mitigate potential systemic risks arising from this deepening integration between private finance and the banking sector,” the European Systemic Risk Board wrote in a September report.
Those risks could intensify if the global economy slows because of US president Donald Trump’s tariffs, the Bank of England has warned.
“The private finance sector has been resilient so far. But having grown rapidly in a low interest rate environment, it is now facing challenges from higher interest rates, and a weaker and more uncertain growth outlook,” the BoE said in its latest Financial Stability Report in July.
The Bank said work was needed to address data gaps that make it hard for regulators to understand how private markets might operate after a shock.
In the same vein, in July, US senator Elizabeth Warren called on the federal government to conduct a stress test on non-bank financial institutions involved in private credit and to analyse how they tie together with the core banking system.
