The private credit market has experienced explosive growth in recent years, emerging as a major alternative to traditional bank lending and public debt markets. Private credit refers to loans provided by non-bank lenders, such as private debt funds, business development companies (BDCs), and institutional investors to companies, often middle-market firms that may be too small or risky for public bond markets or traditional banks. These loans are typically illiquid, privately negotiated, and held to maturity rather than traded publicly.
As of recent estimates, the global private credit market has surpassed $2 trillion in assets under management, with the U.S. portion around $1.3-1.5 trillion. This represents roughly 9% of total corporate borrowing in the U.S., having grown significantly since the Global Financial Crisis as investors sought higher yields in a low-interest-rate environment and companies needed flexible financing.
Key Risks in the Private Credit Market
Private credit offers attractive yields (often higher than public leveraged loans or high-yield bonds) due to its illiquidity and tailored structures, but it carries several key risks:
- Opacity and valuation challenges — Unlike public markets, private credit lacks frequent, transparent pricing. Valuations are often “marked” infrequently, relying on manager estimates, which can mask deteriorating credit quality until stress emerges.
- Credit and default risk — Borrowers are frequently leveraged companies with weaker credit profiles. Default rates have remained relatively low (around 1.8-4% in recent trailing periods, depending on the index), but recoveries have declined in some cases, and distress signals have risen amid a higher interest rate environment.
- Liquidity mismatches — Funds often lock up investor capital for 5-10 years while relying on bank credit lines for short-term liquidity. During period of stress, simultaneous drawdowns on these lines could strain banks.
- Interconnectedness — Private credit funds borrow from banks (commitments reached $95 billion for large U.S. banks by 2025), partner with them strategically, and attract capital from insurers, pensions, and other institutions. This creates potential spillovers if defaults correlate higher than expected.
- Macro sensitivity — Slowing growth could amplify pressures on borrowers, leading to higher defaults or refinancing challenges.
Regulatory bodies like the IMF, Federal Reserve, FDIC, and others have flagged these issues, noting that rapid growth in non-bank financial intermediation (including private credit) could build vulnerabilities if oversight remains limited.
Does Private Credit Pose a Systemic Risk to the Financial System?
The consensus from major 2025 analyses is that private credit does not currently pose a systemic risk to the broader financial system, though it warrants monitoring as it grows and interconnects further. Whether or not that analyses is accurate remains to be seen.
Federal Reserve stress tests in June 2025 (including exploratory scenarios on non-bank financial intermediaries like private credit) found that exposures to private credit and hedge funds did not threaten U.S. banks’ capital or liquidity. Under severe shocks, banks remained above minimum requirements, with limited impacts.
The Federal Reserve’s own analysis of bank lending to private credit vehicles concluded that immediate risks appear limited due to moderate leverage in funds, long-term capital lockups, and banks’ strong capitalization. Drawdown scenarios in stress showed minimal aggregate effects.
The FDIC’s 2025 risk review highlighted vulnerabilities in non-depository lending but noted that bank exposures, while growing, present relatively low direct credit risk and are concentrated in larger institutions.
Fitch Ratings (2025) stated it does not view private credit risks as systemic, despite some “bubble-like” characteristics, as a major shock would be needed to expose broader reach.
Industry views argue systemic fears are overstated: private credits scale remains small relative to total corporate debt (about 9%), and fundraising has tapered, reducing overheating concerns.
However, caveats exist. The IMF and others emphasize that opacity, interconnections, and potential for correlated defaults or liquidity crunches could amplify issues in a severe downturn. If private credit continues expanding rapidly with limited oversight, vulnerabilities might evolve into systemic ones. Harvard and Moody’s analyses note growing network connectivity in stress periods, suggesting the sector’s importance could increase.
It’s important to note that while the financial system has more mechanisms in place to stress test various situations that may develop, and different capital requirements that were not in place prior to the financial crisis of 2008, that does not mean that every risk can be modeled.
Others, such as JP Morgan CEO Jamie Dimon has expressed greater skepticism about the private credit markets. After the bankruptcy of auto parts supplier First Brands, which had borrowed more than $10 billion, Dimon said the following:
“My antenna goes up when things like that happen. And I probably shouldn’t say this, but when you see one cockroach, there are probably more. And so, everyone should be forewarned on this one.”
What we can say is that as a firm we have avoided the use of private credit as an investment vehicle primarily due to the mismatch of the illiquidity it inherently presents, and the average liquidity needs of most investors, particularly those that are retired and dependent on their portfolio as a consistent source of income.
Conclusion
Private credit brings benefits, filling financing gaps for underserved borrowers and offering investors diversification and yield, but its risks are real and could lead to localized pain or broader spillovers in adverse scenarios.
As of early 2026, sources like the Federal Reserve’s stress tests and supervisory data indicate it does not represent a systemic threat to financial stability. Immediate risks seem contained, with banks resilient. Still, ongoing vigilance is needed, as regulators have been very wrong in the past. The market has shown resilience through recent stresses, but an untested prolonged downturn remains a key unknown.
About the Author
Joseph M. Favorito, CFP® is a Certified Financial Planner® as well as the founder and managing partner at Landmark Wealth Management, LLC, a fee-only SEC registered investment advisory firm. He specializes in helping individuals and families develop comprehensive financial strategies to achieve their long-term goals.