Private Credit's $1.7 Trillion Boom: Hidden Contagion or a House of Cards That Holds?

Private credit has quietly become one of the hottest corners of global finance, and its rapid rise is starting to ring alarm bells among the very institutions that helped build it. Once a niche player catering to middle-market borrowers - companies that fall between small businesses and large corporations and are typically underserved by traditional banks - private credit has grown into a $1.7 trillion industry. It is now a key financing engine behind private equity deals, asset-based finance and even retail investor portfolios. The question that increasingly occupies regulators, bankers and academics is whether this boom, if left unchecked, could morph into the next source of systemic risk.

The debate is not a simple argument between optimists and pessimists. It is a dispute about structure: about how opaque the market really is, how tightly it is woven into the rest of the financial system, and what happens when the loans that sit at its core are suddenly repriced. In the United States, where much of the industry's growth has been concentrated, the conversation has sharpened over the past year as record amounts of capital have piled into the asset class and as a new generation of loan structures has begun to appear.

From niche lender to financing engine

To understand the anxiety, it helps to understand what private credit actually is. In broad terms, it refers to loans made by non-bank lenders - private funds, asset managers and specialist credit firms - to companies that do not tap public bond markets. These loans are negotiated privately, held by the funds that make them, and rarely trade. That last feature is central to the whole story: because the loans do not mark to market every day, the industry's defenders say it is insulated from the panic selling that can seize public markets, while its critics say the same feature means stress can build unnoticed until it is too late.

The industry's ascent has been swift. What began as a way for private equity sponsors to finance leveraged buyouts without relying on banks has expanded into a broad ecosystem covering asset-based finance, real estate, infrastructure and, increasingly, retail-oriented products. A $1.7 trillion industry of this scale no longer sits at the periphery of the financial system; it is embedded in it, through the banks that lend to private credit funds, the insurers that invest alongside them and the pension funds that allocate to them.

Why banks stepped back, and who filled the gap

The rise of private credit cannot be understood without the retreat of the banks. After the global financial crisis, regulators on both sides of the Atlantic tightened capital and liquidity rules, making it more expensive for banks to hold riskier corporate loans on their balance sheets. At the same time, the crisis itself left banks more cautious about lending to companies without public credit ratings. The middle market - precisely the segment that private credit now dominates - was left with fewer traditional sources of debt financing. Into that gap stepped non-bank lenders, who were not subject to the same capital charges and could offer the flexible, covenant-light structures that borrowers wanted.

That substitution was, at first, widely welcomed. Companies got financing that banks would no longer provide, and investors got yields that public markets no longer offered. But substitution also means that risks which once sat inside regulated, transparent institutions now sit inside funds that are less visible to supervisors. The loans are still being made; the question is who is watching them, and what happens when the cycle turns. This is the structural backdrop against which every specific warning - about interconnectedness, dry powder or PIK loans - has to be read.

It is worth being precise about where the money comes from, because the answer shapes the risk. The largest pools of capital behind private credit are institutional: pension funds seeking to match long-dated liabilities with long-dated income, insurance companies looking for yield above what public bonds offer, and sovereign wealth funds diversifying their portfolios. These are sophisticated investors with long horizons, and their presence is one reason the industry argues it is not vulnerable to the kind of run that can hit banks. But the same money is also increasingly reaching individual investors through evergreen funds and listed vehicles that promise periodic liquidity. It is at that retail edge - where illiquid loans meet redeemable shares - that the industry's structure is most exposed.

The interconnectedness problem

That embeddedness is exactly what worries Moody's Analytics. In a recent report, the research arm of the rating agency warned that the growing interconnectedness between private credit funds and other financial institutions can amplify financial instability, as evidenced by higher correlation and network connectivity during stress. A more interconnected network of financial institutions may enhance efficiency and capital allocation in good times, the analysts noted, but the increased number of connections also acts as a shock amplifier during periods of market stress.

The mechanism is familiar from past crises, even if the plumbing is new. Opacity means stress can build unnoticed. If investors suddenly demand redemptions, fire sales of illiquid loans can exacerbate market dislocations, because there is no deep secondary market to absorb the selling. As Moody's analysts put it, the same linkages that facilitate risk-sharing in calm conditions can become conduits for contagion under strain. It is a description that echoes the language used about securitised mortgage debt in the years before 2008 - a parallel the industry is acutely aware of, and keen to reject.

Record dry powder and the pressure to deploy

One of the most concrete warning signs cited by industry observers is the sheer volume of capital waiting to be invested. According to PitchBook data, the private debt industry is sitting on $566.8 billion worth of funds ready for deployment - a historic level of dry powder. That idle capital creates its own incentives. Fund managers are paid fees on the capital they put to work, not on the cash that sits in reserve, so there is a built-in pressure to lend quickly.

Shihan Abeyguna, Morningstar's Southeast Asia managing director, spelled out the risk in blunt terms. If the pressure to deploy becomes reality, managers may find themselves lowering lending standards in a bid to lend more money, which leads to a higher default risk. And so yes, he told CNBC, there is the possibility that it could lead to a financial crisis. The logic is straightforward: when a fixed pool of attractive borrowers is chased by a growing pool of money, the price of credit falls, the terms loosen, and the marginal loan - the one that gets made at the top of the cycle - is the one most likely to fail.

Serene Chen, JPMorgan's APAC head of credit, currency and emerging markets sales, echoed the concern about relaxed underwriting standards and less stringent covenants as more capital flows into private credit, including capital from traditional banks. Her caveat was equally important: she thinks that happens with any asset when there is too much money chasing it, but she noted that this is not happening yet. That distinction - between a structural tendency and a present reality - runs through the entire debate.

PIK loans: the debt that pays in IOUs

Perhaps the most closely watched development in the sector is the rising use of paid-in-kind, or PIK, loans. In a PIK structure, borrowers defer cash interest payments; instead of paying cash interest on these loans, the borrower adds more debt, essentially paying by promising even more IOUs. Lenders are not receiving real cash payments - just more paper promises. By skipping cash payments and piling on more debt, companies that borrow on PIK terms end up owing a lot more in the future.

The risk, as industry experts describe it, is that all this unpaid interest quietly adds up, creating a mountain of hidden debt that never appears in a borrower's cash flow statement. David Forgash, a managing director and portfolio manager at PIMCO, noted that what is taking shape is a lot of PIK loans going into private direct lending. In the event of a recession, he argued, private credit will be one of the shoes to drop, given how recessions are bad news for any companies that rely on borrowed money, especially those with a lot of debt.

The PIK debate matters because it goes to the heart of what private credit is supposed to be. The asset class sold itself to investors on the promise of steady cash income - coupons paid in cash, quarter after quarter, by companies too small or too complex for public markets. If a meaningful share of that income is actually being paid in kind, the yield that investors see on paper is partly a mirage, and the true leverage of the underlying companies is higher than the headline numbers suggest. That is precisely the kind of opacity that turns a sector-specific problem into a system-wide one.

The counterargument: cushions, discipline and skin in the game

Not everyone agrees that private credit is the next subprime crisis. Despite the warning bells, many investors and analysts remain confident in the sector's long-term resilience, and their arguments deserve to be taken seriously. The first is about capital structure. Michael Ostro, Union Bancaire Privee's head of private markets in Asia, pointed out that the direct exposure of banks to private credit is relatively limited through their loans to Business Development Companies, or BDCs - the listed vehicles that lend to smaller companies. Most of the lending, he explained, sits atop solid capital structures, often with 50-60% equity cushions. That means even if something goes awry with the businesses that BDCs lend to, those businesses will have to lose over half of their value before the BDCs start taking losses.

The second argument is about behaviour. Suvir Varma, an advisory partner at Bain & Company, believes fears of contagion are overblown. Given the lessons learned from the global financial crisis, he argued, underwriting is now far more disciplined. Private credit managers typically hold the risk themselves rather than slicing and distributing it across the market the way collateralised loan obligations used to do. That is a crucial difference from 2008: when the lender keeps the loan on its own balance sheet, it has every incentive to underwrite it carefully, because it is the one who loses if the borrower fails.

The third argument is about scale. Ostro added that losses to bank loans would require seismic losses at the underlying portfolio levels to really hit them. In other words, even a bad outcome in private credit would have to be catastrophic before it transmitted meaningfully to the banking system. None of this means the sector is risk-free; it means the transmission channels are narrower than the headlines sometimes imply.

What 2008 taught - and what it did not

The shadow of the global financial crisis hangs over every discussion of private credit, and the comparison is instructive in both directions. In the lead-up to 2008, lenders issued risky loans that were bundled with complex financial products such as collateralised loan obligations and sold to investors. The risk was distributed across the system, which meant no single institution felt the full weight of any single bad loan - and that diffusion of responsibility encouraged reckless borrowing and poor underwriting standards. Historically, systems with many interlinked relationships have proven vulnerable in crises.

But there are differences as well as similarities, and they matter:

• In 2008, risk was sliced and distributed through securitisation; in private credit, managers typically retain the loans they originate, keeping the incentive to underwrite carefully.
• The 2008 crisis centred on assets that marked to market daily; private credit loans are illiquid and rarely trade, which cuts both ways - less panic selling, but also less transparency.
• Pre-2008 leverage was often hidden in off-balance-sheet vehicles; today's concern is different, focused on PIK structures that defer interest rather than disguise debt.
• The 2008 system was fragile because everyone believed in the same model at once; today's private credit market is more fragmented, with many managers holding different books.

Ludovic Phalippou, professor of financial economics at Saïd Business School at the University of Oxford in the United Kingdom, offered a measured verdict. While there is potential for fragility, he said, the current financial ecosystem is not comparatively more fragile than it was before 2008. That said, he cautioned that the view that private credit is safe simply because it is not subject to classic bank runs is a bit naïve. The pressure points are different, he argued: investor defaults, margin calls and asset revaluations could create a new type of issues. His summary captured the mood of the debate better than any single statistic: this is not a house of cards, but it smells like one - and it is definitely a house with a lot of mezzanine floors and a very expensive elevator.

What to watch from here

For investors and policymakers trying to separate signal from noise, several indicators stand out. First, the trajectory of PIK usage: if paid-in-kind interest becomes a large share of total income in private credit funds, the sector's reported yields are overstating its cash generation. Second, the pace of deployment of that $566.8 billion of dry powder: if it is lent out quickly, underwriting standards are likely to slip; if it sits idle, fee pressure will build and the temptation to compromise will grow. Third, the behaviour of redemptions in retail-oriented private credit vehicles, where the promise of liquidity and the reality of illiquid loans are hardest to reconcile. Fourth, the growth of bank lending to private credit funds and BDCs, which is the main channel through which stress could reach the regulated banking system. And fifth, the response of regulators, who have so far treated private credit as a sector to monitor rather than to restrain.

The broader lesson is that financial risk rarely announces itself in advance. The 2008 crisis was preceded by years of warnings that were dismissed as alarmist; the private credit debate of 2025 is unfolding in the same pattern, with credible voices on both sides. What is different this time is that the warnings are being issued by the industry's own analysts, rating agencies and academics - and that the structures being questioned, from PIK loans to redemption gates, are visible to anyone who looks. Whether private credit becomes the next source of systemic risk or simply another chapter in the long history of credit cycles will depend less on the size of the industry than on the discipline of the people running it. At $1.7 trillion and growing, the margin for error is smaller than it looks.

Based on reporting by CNBC. Original article: Private credit's trillion-dollar boom is fueling warnings of a hidden financial contagion.