Private credit and systemic risk: what the data actually shows

The financial professional take on  “The Lead Left” newsletter series is dedicated to help financial professionals stay informed about developments, and movements in private capital investing.

Bottom-line upfront

1. Private credit's scale, at roughly $1.3 trillion in total assets deployed, remains too small relative to broader debt markets to pose the kind of systemic risk that defined the 2008 financial crisis.
2. The structural protections built into direct lending, including senior positioning in the capital stack and stronger covenant terms, give lenders meaningful tools to work through credit stress before losses reach the banking system.
3. Private credit's role as a release valve for public markets, demonstrated during the 2022 and 2023 rate cycle, positions the asset class as a complement to broadly syndicated loan and bond exposure in client portfolios.

As conversations about private credit's place in diversified portfolios continue to intensify, the evidence behind the systemic risk debate offers advisors a grounded foundation for client discussions.

Apophenia and the misreading of private credit risk

According to Merriam-Webster, apophenia, or mistaken pattern recognition, is "the tendency to perceive a connection or meaningful pattern between unrelated or random things." We see this happen all the time in capital markets.

After the Global Financial Crisis (GFC), the usual suspects were rounded up. While sub-prime mortgages were clearly the culprits, leveraged loans and collateralized loan obligations (CLOs) were also included, though neither contributed to it. The charges, namely rapid growth, "complexity" and proximity to the banking system, have today put a bullseye around private credit. But the evidence tells a different story.

Why private credit does not meet the threshold for systemic risk

Historically, systemic crises share two defining features: size large enough to matter, and direct linkages capable of transmitting losses across the financial system. Private credit, despite its remarkable growth, is not guilty on both counts.

Private credit size relative to broader debt markets

Start with size. Private credit, including business development companies (BDCs), has about $1.3 trillion in total assets deployed. Sounds significant, but both the leveraged loan and high yield bond markets are larger, each at $1.5 trillion. Where are the op-eds on those assets?

Zoom out further and the picture becomes even clearer. Direct lending represents only 3% of total U.S. household and business debt outstanding (see Chart of the Week). At the height of the GFC, mortgages alone accounted for 60%. By that measure, private credit remains a rounding error.

Bank exposure to private credit and the 2008 comparison

Now consider the linkages. Bank exposure to private credit, referred to as "back leverage," stands at approximately $300 billion. But relative to total bank assets, that is only 1.5%. At the peak of the GFC, subprime assets were nearly 14% of total bank assets. And the structure of these loans also matters. Given loan advance rates of 70% to 75%, meaningful losses would need to materialize before a bank's loan book is impaired.

Private credit as a release valve for public credit markets

The comparison to 2008 also overlooks the fact that direct lending serves as a release valve for public credit. When broadly syndicated loan (BSL) spreads widen, borrowers migrate to private credit. This played out in 2022 and 2023, when the Federal Reserve's rate hikes and Silicon Valley Bank's failure effectively closed the BSL and bond markets for business. Private credit filled the void.

Structural protections in direct lending and private credit

The GFC was defined by opacity, embedded leverage throughout the banking system, and an almost complete absence of equity cushions. Beyond regulatory reform that greatly strengthened bank balance sheets, private credit holds significant advantages over bank loans. It sits senior in the capital stack, carries stronger covenant protections, and direct lenders have additional tools to work through stressed credits before they become non-performing. As with all credit investing, these structural protections reduce, but do not eliminate, the risk of loss, and past performance of private credit as an asset class is not necessarily indicative of future results.

Private credit investments are illiquid, and clients considering an allocation should be prepared for limited access to capital over a multi-year investment period.

Today, the size and linkages of private credit are too small to be considered systemic.

What's next in our private credit series

In the next private credit installment we explore how private credit's structural advantages act as a cycle dampener rather than an amplifier.