The rapid ascension of the private credit market has transformed the credit landscape, offering both competition to traditional banks and an alternative avenue of lending. But regulators have expressed concerns about whether banks’ escalating exposure to opaque and lightly regulated private credit funds could make them more vulnerable to systemic risks, particularly during times of severe market stress.
Private credit funds, non-bank financial institutions (NBFIs) that typically provide direct loans to mid-sized, non-investment grade corporate borrowers, have grown to roughly $2.5 trillion in assets under management, and have taken a bite out of banks’ market share in the lending space. The relationship between banks and private credit funds is nuanced, though. Large banks have, in fact, committed hundreds of billions of dollars in loans to private equity and private credit funds, giving the funds the leverage they need to execute higher-value deals with larger borrowers.
The International Monetary Fund has said the interconnectedness between banks and private credit could potentially present a threat to financial stability. In its October 2025 “Global Financial Stability Report,” the IMF found that U.S. and European banks have $4.5 trillion worth of exposure to NBFIs, including private credit funds.
To gain a more in-depth perspective on the growth of private credit and all its ramifications, ProSight recently spoke with Charles Cohen, the Front Office Advisor on Financial Markets and Financial Stability in the IMF’s Monetary and Capital Markets department.
How do private credit funds differ from traditional lenders, like banks, and how have they changed the competitive lending landscape?
Private credit has evolved over the last few decades. It originally started out mostly aimed at filling the gap, the so-called middle market between what banks did and what was done in public markets—basically companies that were too big for banks to lend to but too small to issue debt securities or syndicated loans. That was a very profitable business for private credit, but they have since expanded. This middle market space has grown, but then they’ve also moved to lending into larger deals, sort of competing more with syndicated loans.
One of the key differences between private credit and banks, in addition to the types of lending they do, is that private credit firms have built very strong relationships with the borrowers and often will take upside in deals—more like equity financing, which tends to have higher returns.
Another very important difference is that private credit has locked-up capital. Whereas banks are deposit funded and face some kind of run risk, private credit firms are structured very much like private equity firms, where capital is called from investors and then returned when deals are done. This so-called liquidity premium is a really critical piece of the private credit business.
In terms of how they changed the lending landscape, I think it’s in two ways: taking some more of the high-valued deals from banks, but now also, in some cases, cutting into the syndicated loan space or even the bond space, where a borrower might choose to do a private deal and forgo some of the issues, like public ratings or roadshows, that are associated with public issuance.
The IMF’s October 2025 “Global Financial Stability Report” found that U.S. and European banks have $4.5 trillion worth of exposure to all NBFIs, including hedge funds and private credit groups. What are the risks of this large exposure?
The fact that the number is so large now really underscores the critical role that non-banks, collectively, are playing in the financial system, both in terms of credit provision and market making. Their role is so large that they are kind of fundamentally interconnected to many aspects of finance and, as we pointed out in our report, their interconnections with banks have been growing.
This has a few ramifications. One is there is this obvious sense of spillover—so if there are risks that are found in these private, non-bank markets, they may now spill over into banks, through their lending relationships. So that’s kind of a credit risk contagion.
The other point we bring up in our report is the liquidity risk effects. During some stressed periods, some of these non-banks may be drawing lines of credit from the banking system, which would place liquidity strains on the banks, likely at a time where they may be facing other stresses. So this is something that we think is very important to monitor.
The question about whether this is potentially a threat to financial stability, I don’t have a glib answer to that, as bank/non-bank relationships are highly complex and encompass a wide variety of different issues. Given that all these exposures are large, it does mean that all these risks need to be continually monitored, so that we understand the nature of these relationships.
Banks have lost some market share in the traditional lending space, with more and more businesses turning to private credit when they need loans. However, large banks have issued $300 billion of loans to private equity and private credit funds, according to a 2025 study by the Federal Reserve Bank of Boston. Do you see private credit as competition for banks or as an alternative source of lending?
Private credit is potential competition but also potential partners for banks. Over the last few years, we’ve seen very large deals struck between major banks and major asset managers who specialize in private credit. So, clearly banks understand that this is a very important new space, and that they need to be aligned with players in this space.
You can think of this cooperation as a sort of divvying up of risks in the capital structure. It used to be that private credit firms were just doing direct loans, and the loans were fully owned by them, and the returns were high enough. Now that the space is getting larger, they have to find larger deals, maybe with lower yields. So, to enhance their return, they go and put leverage on those deals … and often that leverage will be funded by the banks.
The banks like this because they get a nice return on these portfolios that they are leveraging, and the private credit firms like it because it enhances their return. That being said, there also are cases where you can have direct competition. So, for example, I can borrow in public markets for certain types of companies for syndicated loans or go private. You pay a little bit more for going private, but, again, there are benefits.
So, I think this space is evolving. When you look at these partnerships, you see that this space is important to banks, and that they need to find ways to remain competitive in it.
Does the increased interaction between banks and private credit funds present any potential systemic risks? Are there any scenarios under which banks could suffer significant losses because of their links to private credit?
That’s a very good question—one that we’ve been thinking about a lot. As I mentioned earlier, the first point to consider is the nature of this interconnection between private credit and banks.
At this point, frankly, it’s hard to get the details on how exactly these kinds of deals are structured. But I think what’s mostly showing up is the fact that banks are providing senior leverage to these private credit institutions. Since the leverage is senior, I think that provides some mitigants against losses for banks and makes them feel more protected. They can call for additional collateral from the funds if they must.
We know that there is still risk, though, and that it comes from the fact that private credit is a rapidly growing asset class—and one that hasn’t really seen its performance in a serious correction. With new asset classes that are growing rapidly and have sort of only existed in bull markets, one thing you always have to consider is how they will perform in bear markets.
If a bear market happens, there is the potential under extreme scenarios that banks could see losses. I don’t think that’s something that we forecast as any kind of base case, but we want to keep a careful eye on this going forward. Understanding the nature of the leverage that private credit firms are receiving, and how much cushion the banks have against a downturn in the private credit market, is critical.
