Global regulators sound the alarm: $2 trillion private credit market harbors "systemic risk"

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Global financial regulators are warning about systemic risks in the private credit market, demanding that countries strengthen oversight of this industry, which is now nearly $2 trillion in size.

In a deeply researched report released Wednesday, the Financial Stability Board (FSB) pointed out that the private credit market suffers from a lack of standardized data, opaque valuations, and complex financing structures, all of which are transmitting vulnerabilities to the broader financial system. The FSB is composed of G20 central bank governors, regulators, and finance ministers. The report warns that the industry's growing links with banks, insurers, and asset managers could amplify systemic shocks should any stress event occur.

Meanwhile, the private credit exposures of several major European banks have drawn intense market attention this earnings season. Barclays disclosed an exposure of $20 billion, Deutsche Bank around $30 billion (about 2% of its total loans), and BNP Paribas $25 billion (about 3% of its total loans). The European Central Bank and the Bank of England have both recently expressed concerns over the potential systemic risks from private credit.

Banks and Private Credit: Deep Links, FSB Flags Three High-Risk Channels

The FSB has identified the increasingly complex ties between banks and the private credit market as a core source of risk.

According to FSB statistics, banks have extended a combined $220 billion in drawn and undrawn credit facilities to the private credit industry, but commercial data suggest the actual figure may be twice as high. The FSB notes that, although this amount is still a small share of banks' Common Equity Tier 1 (CET1) capital, other connection channels could further magnify risk.

The report specifically highlights three types of high-risk links: banks providing high-risk financing arrangements for investment portfolios; banks offering revolving credit lines to companies that also borrow from private credit funds; and increasingly common private-credit-centered strategic partnerships between banks and asset managers.

Concerns over Credit Quality: Rise in Payment-in-Kind Loans

The FSB report expresses clear concerns over the underlying asset quality in the private credit market.

The report points out that leverage in the industry is concentrated in sectors such as technology, healthcare, and services, which have yet to undergo a full economic downturn. Of particular note, some borrowers are increasingly relying on payment-in-kind (PIK) loans, that is, repaying interest with new debt instead of cash—which the FSB views as a potential warning sign of deteriorating credit quality.

Tensions are also rising in the U.S. market, involving exposures in the software sector, business development companies (BDCs), and certain corporate credit events. Meanwhile, as retail investors access the market through semi-liquid public trading vehicles, redemption pressures have recently become evident in the U.S. market.

Regulatory Call: Fill Data Gaps, Strengthen Liquidity Supervision

In light of these risks, the FSB is urging national regulators to take concrete action to fully strengthen supervision of the private credit industry.

The FSB's proposed enhancements cover multiple areas: promoting expertise-sharing between banks and non-bank institutions in risk management and corporate governance, including mechanisms for aggregate exposure, valuation methods, and private ratings; filling gaps in loan-level data; and intensifying oversight of liquidity mismatches.

In terms of market size, private credit totals about $1.5–2 trillion, dominated by the U.S. market, with the Eurozone and UK following. The sector has rapidly expanded since the 2008 global financial crisis, as private credit funds and other alternative investment vehicles filled the financing vacuum left after investment banks pulled back from high-risk debt markets. The Bank of England is now working with the industry on stress tests. Its deputy governor, Sarah Breeden, last month explicitly expressed concerns over asset quality, valuation discipline, and liquidity.

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