The Next Financial Crisis Could Start in Private Credit, Not Banks—and We Might Not See It Coming

The private-credit crowd tends to speak in the language of calm outside a glassy Midtown hotel ballroom, the type with the lighting that flatters everyone and the thick carpet that swallows footsteps. “Covenants.” “Downside protection.” “Resilience at floating rates.” Coffee is always available, as is the quiet assurance that this area of finance is more resilient than the ostentatious public markets. However, you can sense the micro-tremor in casual conversations these days, as people lower their voices when discussing redemption limits or how banks have been using leverage to enter a market that was ostensibly created to circumvent banks.

In its most basic form, private credit refers to lending that is done outside of traditional banks to midsize businesses. These loans are frequently held by funds rather than being traded on open exchanges. The pitch is well-known: yields that make pension trustees sit up straight, more control than syndicated loans, and less volatility than high-yield bonds. According to Brookings, it is a rapidly expanding segment of business finance that is now significant enough to cause regulators to question what will happen when the cycle reverses. The cycle never stops. Whether or not we have designed the exits is the only question.

The unsettling aspect is that the attractiveness of private credit hinges on factors that appear stable—until they don’t. Unlike stocks, loans aren’t marked every second. They do not have to endure the humiliation of a ticker tape every day. Pricing is smoother, slower, and nearly courteous. For investors who don’t like drama, that’s reassuring, and it’s also how danger can go undetected. People can act as though there is no volatility when assets are difficult to value quickly—that is, until someone demands money and finds the market has no good answer.

Rarely does a real crisis start with a tidy headline that reads, “SYSTEMIC RISK.” A few uncomfortable phone conversations, a few funds tightening their terms, and investors realizing that “monthly liquidity” is a marketing gimmick rather than a physical law are the first steps. Instead of causing the underlying fear, the recent rumors about Blue Owl—following a fund that restricted withdrawals—merely brought it to light like a tiny crack. Instead of reading footnotes, shareholders reacted by running, as is customary in the finance industry.

Losses on private credit are not the greater concern. Losses are common. The concern is that the losses won’t be contained in a courteous manner. Banks lending to private-credit firms and funds, banks providing facilities, and banks sitting closer to the machinery than many casual investors realize are just a few of the growing connections between banks and private credit that the Federal Reserve has been mapping. It feels like we’ve replicated a well-known setup: take a chance on moving into the shadows and then use the controlled system’s flashlight when it gets dark.

The “not banks” portion of the headline starts to get hazy at this point. Regulators pushed traditional banks to look less like casinos and hold more capital in the years following 2008. In response, some segments of the market, predictably, constructed a casino next door with fewer windows. Due in part to its ability to act swiftly, negotiate custom terms, and provide borrowers with certainty, private credit flourished. It also thrived because it provided the yield that institutional funds—such as endowments, insurers, and pensions—needed. That isn’t necessarily a bad thing. Furthermore, it isn’t always safe.

At first glance, the mechanics of a future blowup would probably appear uninteresting. Borrowers fail to meet their goals. Amend-and-extend agreements save time but raise concerns. An excessive number of investors are vying for the same limited opportunity in a fund that promised periodic liquidity. In the meantime, just as private vehicles draw on credit lines, banks that are under their own strain may withdraw. The term “liquidity mismatch” describes a very human phenomenon: everyone attempting to depart at once and finding the hallway to be smaller than promised.

The data issue is what makes this more difficult. Markets and regulators perform better when they can see. By its very nature, private credit is less transparent—it relies more on internal models and appraisals, has less standardized reporting, and offers fewer real-time price signals. According to Brookings, as the industry expands, financial authorities have been raising concerns about stability risks. In its own way, the Bank of England has also been warning about increased risks and the uncertainty that looms over the system—words that sound dull until they suddenly become prophetic.

The worst fears—that investors will accept longer lockups, that the big managers will handle, and that private credit’s structures will prove sticky—may be exaggerated. Some voices contend that the panic is more social media contagion than balance sheet contagion and more narrative than math. But it’s not just math that causes crises. They have to do with self-assurance. Furthermore, confidence has the annoying tendency to erode more quickly than spreadsheets can be updated.

Even though it is difficult to acknowledge, there is a subtle déjà vu feeling as you watch this happen: a successful product that was marketed as safer than the last crisis, growing until it is significant enough to matter, and then discovering—publicly—that responsibility comes with importance. History loves to repeat itself, so a bank could still be the starting point for the next financial crisis. However, private credit has produced a credible alternative path, one that is lined with institutional optimism, low valuations, and just enough bank plumbing to allow trouble to spread if it needs a place to go.