May 2026
Private credit has become a major source of corporate financing, but its rapid expansion shifts risks outside bank balance sheets without eliminating them. Opacity, leverage, illiquidity and growing interconnections are creating new vulnerabilities within the financial system that warrant closer oversight.
The rise of private credit has been one of the most significant financial developments of recent years. Long regarded as a niche segment, it has become an important source of funding for companies, particularly mid-sized firms and transactions considered too risky or too specialized for traditional bank lending. This growth reflects a genuine economic rationale: companies seek more flexible, accessible, or complementary sources of financing, while investors search for higher yields. Yet it also raises an increasingly pressing financial stability question. As credit migrates away from bank balance sheets, risks do not disappear; they merely change form, ownership, and transmission channels.
To fully understand the issue, it is useful to distinguish between a bank and a non-bank financial intermediary. A bank creates deposit money, collects deposits, transforms liquid liabilities into longer-term loans, has access to central bank liquidity facilities, and operates under a stringent prudential framework. When a bank grants a loan and retains it rather than securitizing it, the associated credit risk remains on its own balance sheet. If the borrower’s creditworthiness deteriorates or defaults, the resulting cost is reflected in provisions and ultimately in earnings. Unless the bank itself is threatened, depositors do not directly bear the cost of credit losses. Banks also assume interest-rate and liquidity risks. Banking regulation largely stems from this reality: because banks create broad money, operate payment systems, and safeguard a significant share of household and corporate savings through deposits, they are subject to strict prudential requirements. For the same reason, central banks can act as lenders of last resort to prevent a financial or banking crisis from spiralling into a systemic collapse.
Risk Transferred to Investors
Private credit funds operate according to a fundamentally different model. They do not collect deposits, perform a monetary function, or generally have access to central bank refinancing. Most importantly, they do not themselves bear credit, interest-rate, or liquidity risks. Those risks are transferred directly to the investors who commit capital to the fund and who, in exchange for higher expected returns, agree to absorb potential losses. This structure has an internal logic: it enables the financing of riskier segments without directly exposing depositors to those risks. However, it also has a downside. When risk is not internalized by the intermediary itself, balance-sheet discipline becomes more diffuse, oversight more fragmented, and market reactions during periods of stress potentially more abrupt.
Since the global financial crisis, banks have been subject to significantly stricter prudential requirements. This has strengthened their resilience, as was necessary, but it has also contributed to shifting part of corporate financing—particularly the riskiest and least standardized segment—outside the banking sector. At the same time, years of exceptionally low interest rates encouraged insurers, pension funds, family offices, and other institutional investors to seek higher returns in less liquid and riskier assets. Private credit has flourished at the intersection of these two trends: tighter constraints on banks and a growing appetite for yield among investors.
Multiple Vulnerabilities
This new form of credit intermediation nevertheless concentrates several vulnerabilities. The first concerns the quality of borrowers themselves. Companies financed through private credit are often unrated or only lightly covered by public rating agencies, and may exhibit fragile capital structures and elevated leverage. Aggressive deal structures, covenant-light loans, payment-in-kind (PIK) features, and discreet restructurings can delay the visible recognition of losses without reducing the underlying risk. In other words, credit deterioration may take longer to appear in valuations than in the underlying economic reality.
A second vulnerability lies in the sector’s limited transparency. Unlike publicly traded bonds, private loans do not trade on organized and liquid markets. Their valuation relies on models based on imperfect comparables and internal assumptions. This opacity is not merely an information issue for investors. It is also a macroprudential concern, as it delays the recognition of losses, complicates risk comparisons across market participants, and may foster a misleading perception of stability. The growing use of private ratings adds a further layer of ambiguity. While such ratings may broaden the investor base, they may also facilitate forms of regulatory arbitrage if their quality and consistency are not adequately ensured.
A third vulnerability stems from interconnections. Private credit does not operate in isolation from the broader financial system. Banks provide credit lines to funds, finance portfolios, share borrowers, and increasingly form partnerships with major asset managers. Insurers and pension funds invest in private credit to capture illiquidity premia that appear compatible with their long-term liabilities. Private equity groups may simultaneously control lending platforms and insurance companies, multiplying potential channels of contagion. The systemic risk therefore does not arise from an isolated “shadow sector,” but from an increasingly dense web of relationships among banks, non-bank financial institutions, insurers, and investment vehicles.
Liquidity Under Scrutiny
A growing liquidity risk must also be considered. As long as private credit is primarily financed through closed-end funds, the mismatch between investor liabilities and the illiquid nature of the underlying assets remains relatively limited. However, the rise of evergreen vehicles, semi-liquid structures, and products aimed at a broader investor base is altering this balance.
Whenever a degree of liquidity is promised to investors while the underlying loans remain difficult—or potentially impossible—to sell quickly, a mismatch emerges. In periods of stress, such mismatches can trigger forced sales, sharp markdowns, and spillovers into other market segments. This is precisely the type of vulnerability often highlighted in discussions of non-bank financial intermediaries (NBFIs): institutions that do not create money but can nevertheless become powerful amplifiers of instability through liquidity demands and asset sales.
A Useful Market That Requires Better Oversight
The debate should not be caricatured. Private credit is not inherently problematic. It addresses genuine financing needs and can usefully complement bank lending. The problem arises when the growth of this form of intermediation creates the illusion that risk has diminished simply because it has migrated away from bank balance sheets.
Transferred risk is not eliminated risk. When borne by end investors, valued infrequently, financed through leverage, and embedded within complex structures, risk may actually become more difficult to identify and more costly to contain once it materializes.
For this reason, the appropriate response is neither laissez-faire nor the mechanical extension of banking regulation to institutions that perform different functions and possess fundamentally different liability structures.
The first requirement is greater transparency. Authorities should harmonize definitions of private credit, impose more consistent reporting standards, and obtain sufficiently granular information on funds, loans, credit quality, leverage, liquidity terms, and interconnections with banks and insurance companies. As long as this mapping remains incomplete, supervision will remain behind the curve.
The second requirement is a more cross-sectoral approach to supervision. The risks associated with private credit cannot be properly assessed within separate silos of banking, securities-market, and insurance supervision. Regulators need to monitor consolidated exposures, cross-financing channels, leverage, and liquidity risks across the financial system as a whole. Such an approach is essential to identify areas where an apparently localized shock could become systemic.
The third requirement is proportionate regulation of amplification mechanisms. This implies stricter oversight of valuation practices, greater scrutiny of private ratings, limits on excessive leverage at the fund level, and more robust requirements regarding margins, haircuts, and consistency between promised liquidity and the actual liquidity of underlying assets. The objective is not to restrict non-bank financing but to prevent it from becoming a major source of instability through the absence of adequate safeguards.
Many of these measures are already advocated by national and international institutions responsible for safeguarding financial stability.
A Turning Point for Private Credit
Private credit is now at a pivotal stage of its development. Its growth demonstrates the financial system’s capacity to innovate and to meet financing needs that banks no longer fully satisfy on their own. Yet it also reminds us of a familiar lesson: the further risk moves away from the perimeter where it has historically been most closely monitored, the greater the temptation to assume that it has become less significant.
The opposite is often true.
When banks retain the loans they originate, they absorb the associated costs on their own balance sheets. When private credit funds finance similar risks, it is investors who ultimately bear the losses. Such a transfer may be economically justified, but it does not warrant prudential complacency or regulatory leniency.
As private credit becomes increasingly systemic, supervision must evolve and strengthen alongside it.
Private Debt and Risk:
Three Key Takeaways
- Private credit meets a genuine corporate financing need, but it does not eliminate risk; it transfers it from bank balance sheets to investors.
- Its rapid expansion increases several sources of systemic vulnerability, including opaque valuations, elevated leverage, illiquid assets, and strong interconnections with banks, insurers, and investment funds.
- The key challenge is therefore to establish a supervisory framework that is more transparent, cross-sectoral, and proportionate, capable of containing amplification mechanisms without unnecessarily constraining this important source of financing.
Olivier Klein
Professor of economics at HEC