Private Credit: Seeing the System Clearly

The headline caught my attention: ‘Private credit could “amplify” next financial crisis, study finds’. It appeared in the Financial Times recently, summarising findings from a comprehensive report from Moody’s Analytics that uses sophisticated econometric tools to examine how private credit has become more central to financial contagion during stress periods.

This is not my usual domain - I am more at home analysing the governance structures that shape financial decision-making than dissecting loan covenants or fund structures. But as someone who has spent years watching how systemic risk migrates through financial systems, I find myself drawn to what these developments might mean for how we understand and manage financial stability.

The Moody’s study, published in this month, employs principal component analysis and Granger-causality network modelling to map interconnections across the financial system. Their findings suggest something significant: during periods of stress, business development companies (BDCs) - their proxy for private credit - have become more prominent in the network of financial linkages, while banks have become relatively less central. Moody’s argues the financial system has shifted from a ‘hub and spoke’ structure centred on banks to a denser, web-like configuration - where private credit now occupies critical nodes.

The Growth and Scale

Private credit - essentially nonbank lending to companies, often middle-market firms that fall between traditional bank loans and public bond markets - has grown explosively since the global financial crisis. From a niche asset class, it has expanded to roughly $2 trillion in global assets under management, with about three-quarters concentrated in the United States. To put this in perspective, it now rivals the high-yield corporate bond and syndicated leveraged loan markets in size.

“Unlike public markets, most private credit offers no real-time pricing and relies on bespoke contracts”

This growth was not accidental. Post-crisis banking regulations tightened capital and liquidity requirements for traditional lenders, creating space for institutional capital to fill the gap. Private credit funds stepped into this void, offering speed and customised terms to borrowers in exchange for higher interest rates than typical bank loans. What began as direct lending to middle-market companies has since expanded into specialty finance, asset-based lending, and increasingly complex structures.

Emerging Systemic Concerns

The concerns are not just about size - they are about structure and visibility. Recent analysis from multiple regulators highlights several interconnected risks. The IMF’s April 2024 Global Financial Stability Report warns that private credit’s growth creates potential risks if the asset class remains opaque, noting that ‘credit migrating from regulated banks and relatively transparent public markets to the more opaque world of private credit creates potential risks’.

The Moody’s study documents how this opacity combines with increasing interconnectedness. Banks are becoming more involved in private credit through partnerships, fund financing, and structured risk transfers that allow them to maintain economic exposure while shifting assets off balance sheet. While such arrangements may offer capital efficiency, they can also obscure the true distribution of risk.

“What began as direct lending to middle-market companies has since expanded into specialty finance, asset-based lending, and increasingly complex structures.”

Three particular vulnerabilities stand out from the research. First, layered leverage creates cascading risks - borrowers with high debt-to-EBITDA ratios funded by funds that themselves use subscription lines and other credit facilities. The Moody’s report notes that private credit managers are increasingly financing their loan portfolios through private collateralised loan obligation structures, with well over $100 billion of private credit CLOs outstanding. This introduces another layer of leverage and structural complexity that is not always visible to end investors.

Second, liquidity mismatches are emerging as funds experiment with semi-liquid structures to attract broader investor bases. These models introduce a potential duration mismatch, as funds commit to holding long-dated, illiquid assets while offering investors periodic liquidity supported by credit lines or cash buffers.

Third, transparency gaps complicate risk assessment. Unlike public markets, most private credit offers no real-time pricing and relies on bespoke contracts. As the Moody’s report observes, private credit’s lack of standardisation and limited disclosure complicate efforts to monitor its risks. Mark-to-model assets are vulnerable to swings in market confidence, and when pricing gaps emerge, attention quickly shifts to the balance sheets of those holding similar exposures.

Recent regulatory analysis supports these concerns. The Federal Reserve’s May 2025 research reveals that banks have become a key source of liquidity for private credit lenders through credit lines, with 22% of large U.S. banks’ commercial loans now going to private credit-backed firms. The European Central Bank warns of ‘hidden leverage and blind spots’ from growing interconnections between banks and private market funds, noting that exposures ‘can involve layered leverage’.

Shadow Banking Echoes?

These developments inevitably invite comparisons to pre-crisis shadow banking, though the parallels are not straightforward. Recent academic analysis reveals structural similarities: 63% of private credit loans lack standardised covenants compared to 41% in 2007 syndicated loans, and 35% of funds use leverage exceeding 2:1, approaching 2006 CLO levels.

Yet, there are meaningful differences. The investor base is fundamentally different - dominated by pensions, insurers, and endowments rather than the retail-driven flows that characterised pre-crisis structured products. The Systemic Risk Council’s May 2025 report explicitly places private credit within ‘shadow banking’s global risks,’ while acknowledging that longer lock-up periods may reduce near-term liquidity risks compared to pre-crisis structures.

The Moody’s study captures this evolution well: ‘Rather than a hub-and-spoke centred on large banks and broker-dealers as was the case in the GFC, the network is more distributed. BDCs and other nonbanks have become more central to network connectivity over time, while banks’ centrality has somewhat diminished.’

Risk has not vanished - it has changed form, location, and visibility. Where pre-crisis risks concentrated in bank-backed off-balance-sheet vehicles, today’s risks may be dispersed across private vehicles with limited regulatory visibility.

Financial Governance Implications

From a governance perspective, what strikes me most is how this evolution challenges our existing frameworks for understanding and managing systemic risk. We have spent the post-crisis years strengthening bank oversight and improving transparency in public markets, but systemically important activities have quietly shifted to spaces with different oversight regimes.

The Moody’s report argues that regulators should consider expanding the regulatory perimeter to include significant private credit funds, enhance transparency through improved reporting requirements, and integrate private credit trends into macroprudential policy frameworks. They suggest that central banks should consider how they would respond if a systemic event in private credit markets materialised, noting that traditional lender-of-last-resort tools may not reach these markets directly.

This is not about stifling innovation or imposing bank-like regulation on fundamentally different institutions. It is about ensuring that our risk monitoring tools can see clearly across the financial system as it actually operates today, not as it operated fifteen years ago. The Financial Stability Board’s 2024 annual report acknowledges this challenge, noting ‘private credit is growing rapidly and there is increasing evidence of its connections with the banking system and with institutional investors’ while highlighting the opacity that makes assessment difficult.

The International Organization of Securities Commissions has begun updating frameworks around liquidity risk management and valuation principles for collective investment schemes, indirectly addressing some transparency issues relevant to private credit. However, these efforts remain fragmented across different regulatory domains.

The Path Forward

I enter this conversation not as a private credit expert, but as someone who has watched how financial systems evolve and how governance structures struggle to keep pace. What concerns me is not necessarily the growth of private credit itself - it appears to serve legitimate economic functions and has attracted sophisticated institutional investors who understand the risks they are taking.

What concerns me is the possibility that we are creating new systemic vulnerabilities without adequately updating our tools for seeing and managing them. As the Moody’s study notes, ‘the lack of transparency allows risks to accumulate. Data gaps remain a serious issue in the current landscape, as there is limited information on loan covenants, true portfolio valuations, and the overlap of fund investors’.

This echoes past moments - like the 1990s derivatives boom or the 2000s structured credit surge - where innovation moved faster than oversight. The lesson from those episodes is not that innovation is inherently dangerous, but that transparency and appropriate oversight need to evolve alongside market structures.

If private credit is here to stay - and it is - we owe it to ourselves to see it clearly. The consequences of not doing so are all around us, if we care to look.