The $2 Trillion Question: How Much Private Credit Risk Sits Inside Banks
Global regulators warned that banks hold hundreds of billions in direct and indirect exposure to private credit funds just as default rates reached records, with U.S. lending to the sector estimated above $300 billion.
The Financial Stability Board published a report this week warning that vulnerabilities in private credit have grown large enough to matter for global financial stability, arriving at the end of a quarter in which default rates in the sector reached records.
The industry has grown to roughly $2 trillion in assets, built during a decade in which regulated banks retreated from leveraged lending and institutional investors reached for yield.
The numbers moving in the wrong direction
Fitch Ratings put the U.S. private credit default rate at 6.0% in April, a record for the sector. A widely followed index maintained by a law firm active in the market recorded a 2.73% default rate in the first quarter across nearly 700 loans totaling $189 billion, up from 1.84% two quarters earlier.
The gap between those figures illustrates the measurement problem. Definitions vary, and a substantial share of stressed loans are restructured into payment-in-kind arrangements — where the borrower pays interest in additional debt rather than cash — which postpones a formal default without improving the underlying credit.
Where banks connect
Banks are not primarily direct lenders to the companies in question. They are lenders to the lenders. Estimates put U.S. bank credit extended to private credit funds, business development companies and collateralized loan obligation structures at roughly $300 billion, with some measures above $320 billion.
That exposure is typically senior, secured and over-collateralized, which is why banks describe it as low risk. The FSB's report identifies the complication: the same handful of banks provide financing to many funds holding overlapping borrowers, so the diversification is less than it appears on any one balance sheet.
One large European bank disclosed roughly $30 billion in private credit exposure in March, a disclosure that hit its share price and prompted investors to start asking every other institution the same question.
Four vulnerabilities
The FSB grouped its concerns into four clusters: interconnection with banks, opacity in borrower credit quality and asset valuation, concentration combined with liquidity mismatches in funds offering periodic redemptions, and data gaps that leave supervisors estimating rather than measuring.
Several of the largest funds faced heavy redemption requests earlier this year — the specific mechanism through which an asset-quality problem becomes a liquidity event.
Why it is hard to regulate
Private credit was created, in part, by regulation. Rules that made leveraged lending expensive for banks moved it to funds where it is cheaper — and less visible. Tightening the rules on the funds would push the activity somewhere else again.
That is the policy trap supervisors have been circling for two years, and it is why the FSB's recommendations focus on disclosure and data collection rather than on capital requirements for the funds themselves.
