Private Credit’s Shadow Banking Boom Carries Familiar Risks

Should private credit worry policymakers and regulators? The question has gained urgency after repeated warnings from the CEO of the world’s largest bank, who has argued that exposures linked to the sector could become a major source of instability. Yet international regulators appear far less alarmed. The divergence stems from how each side interprets the risks embedded within a rapidly expanding and highly opaque market.

The principal concern is the absence of transparency. Information remains sparse, while the extent of interconnectedness across the financial system is difficult to assess. In periods of stress, such blind spots can trigger a domino effect.

According to estimates by the US Federal Reserve, the American private credit market was worth about $1 trillion in 2023 and had grown to $1.3 trillion by 2025, accounting for roughly three-quarters of the global market. Western Europe and Canada comprise most of the remainder. Yet several private estimates, including one from Morgan Stanley in 2025, place the market closer to $3 trillion.

A Federal Reserve study last year concluded that stress in private credit markets posed negligible danger to the banking sector and would have virtually no impact on bank capital through existing linkages. That conclusion may reflect optimism more than prudence.

Consider the scale involved. The stock of sub-prime securities that precipitated the 2008 financial crisis was under $1 trillion, barely a third of today’s estimated private credit universe. Yet the collapse of those instruments destabilised the global financial system and imposed severe economic hardship worldwide.

Hidden Leverage
Private credit is, in essence, a sophisticated form of debt investing for wealthy institutions and individuals, where both the loans and the borrowers are largely unlisted. The risks are undeniably higher, but so are the returns. Empirical studies suggest private credit loans generate spreads more than three times those earned on conventional bank lending.

Economist Thomas Piketty explains in his seminal work (2013) that large corpuses from the rich access higher returns and expand the gap with the rest and will increasingly do so. Private credit does just that.

Crucially, these funds are rarely financed solely by investor capital. They are leveraged as well. Investor contributions are supplemented with borrowings, often sourced from banks. Additional financing comes from non-bank financial institutions, including other investment funds. Fee income from loan origination and securitisation activity further augments their resources, especially when loans are sold onward to insurers and institutional investors. These combined pools of capital are then deployed either to originate fresh loans or to acquire existing securitised assets.

This interconnectedness creates vulnerabilities at multiple levels. A portion of investor commitments, for instance, remains subscribed but unpaid. Some regulators view these uncalled commitments, often termed “dry powder”, as a source of resilience. That confidence may be misplaced. Investors can default even on their crystallised losses - as in the case of Archegos Capital. It defaulted on the amounts it owed to the erstwhile bank Credit Suisse, with the impact bringing down the bank eventually.

Estimates from rating agencies suggest banks have direct lending exposures of roughly $300 bn to private credit firms. Regulatory assessments from 2023 indicated that nearly 60% of these exposures were concentrated among the five largest US banks. Subsequent disclosures suggest those numbers have only risen since then.

Indirect exposures are even more difficult to quantify. Banks have extended trillions of dollars in financing to investment-oriented non-bank financial institutions, including insurers, pension funds, sovereign wealth funds, endowments, family offices, hedge funds and asset managers. Many of these entities are significant investors in private credit. For banks, the structure offers attractive capital arbitrage opportunities.

Insurance companies may represent another weak link. Many have absorbed billions of dollars of private credit exposure through structured products such as Rated Note Feeders and Collateralised Fund Obligations. To some observers, these instruments evoke uncomfortable parallels with the layered securitised products and CDOs that amplified the 2008 crisis and contributed to an otherwise collapse of the insurer AIG, but for a regulatory bailout.

Ultimately, the entire edifice rests on the quality of the underlying loans. Outstanding exposures now run into trillions of dollars across both direct lending and structured financial products linked to private credit assets. Yet questions remain about whether credit origination standards are sufficiently robust within a sector that operates largely outside the perimeter of conventional banking regulation.

In the deeply interconnected financial system, private credit occupies a portion, yet it is highly leveraged and increasingly dependent on opaque channels of credit creation. That combination should concern regulators far more than it currently does.