Report: Private credit opacity poses risk to financial system

Key takeaway: The private credit market, with an estimated size of $1.5 to $2 trillion, poses a challenge to regulators tasked with monitoring the sector because data collection is fragmented or locked behind paywalls. Expert quote: “This web of interlinkages may create challenges for banks in effectively managing their direct and indirect risks. Fragmented oversight increases the difficulty of identifying and addressing risks that may arise from these interlinkages.” — Financial Stability Board.What’s at stake: Interconnectedness between banks and the private credit market through complex funding structures can create spillover risks in an event of a downturn. 

The rapid growth and opaque nature of private credit could pose risks to the broader financial system, according to a May report from the Basel, Switzerland-based Financial Stability Board.

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The report said interconnectedness in the financial system, combined with limited transparency into private credit borrowers’ financial health, makes it difficult to assess how stress in the sector could spread across markets or to identify early warning signs of a downturn.

It highlighted the growing role of banks in the private credit ecosystem, calling them “a critical node” through activities such as financing private credit funds and investing in collateralized loan obligations, or CLOs, while warning that such exposure could carry risks.

“This web of interlinkages may create challenges for banks in effectively managing their direct and indirect risks,” the report said. “Fragmented oversight increases the difficulty of identifying and addressing risks that may arise from these interlinkages.”

The FSB report also said some banks struggle to aggregate exposures and conduct effective stress testing, particularly in complex arrangements involving private credit funds. It added that the growing complexity of relationships between banks and private credit firms underscores the need for stronger risk management frameworks and greater transparency to monitor and mitigate vulnerabilities across the financial system.

Globally, the private credit market has grown to an estimated $1.5 trillion to $2 trillion and includes a range of participants such as asset managers, insurers, pension funds and banks. The report attributed the expansion of the market to easier access to financing compared with traditional sources, such as banks and capital markets. However, it said measuring the size and scope of the market remains difficult because of “several overlapping categories of definitions,” which complicates global assessment. It also cited fragmented data, inconsistent reporting and paywalled information as challenges for regulators monitoring the sector.

The FSB said private credit remains largely untested at its current scale, raising the possibility that an economic downturn could expose leverage and credit quality weaknesses.

“Opinions within the market are divided,” the report said. “Some remain optimistic, suggesting that a significant economic downturn would be required to generate meaningful credit losses, while the impact would be unlikely to be systemic. Others view private credit as the most likely source of a systemic credit event.”

The opaque nature of private credit has drawn increased attention from U.S. prudential regulators.

In May, Treasury Secretary Scott Bessent met with state insurance commissioners and the National Association of Insurance Commissioners to discuss insurers’ growing exposure to private credit and whether it poses risks to policyholders.

At the meeting, Bessent said the Treasury Department is closely monitoring insurers’ increasing involvement in private credit to ensure state-based oversight remains effective. Regulators also emphasized ongoing efforts to track private credit exposures and protect policyholders.

Separately, Jerome Powell, former head of the central bank, said in a March appearance that the Federal Reserve is closely watching the private credit space, though there are currently no signs of contagion.

“Supervisors are well aware of what the bank’s exposure is and what is not,” Powell said. “I’m reluctant to say anything that suggests that we’re dismissive of the risk, but we’re looking for connections to the banking system that might result in contagion. We don’t see those right now.”