Don't be fooled by the scaremongering around private credit

Eric Lee/Bloomberg

• Key insight: The current rash of redemptions from private credit funds betrays a misunderstanding of the strengths underlying the business model.
• Expert quote: The private credit sector "has the potential to enhance financial stability and expand economic growth, since it matches longer-maturity loans with longer-term funding." —Federal Reserve Governor Lisa Cook speaking at Georgetown University.
• Forward look: When bank products won't work, private credit can step in with lending that fits complex projects.

The ongoing conflict with Iran, volatile oil prices, AI innovations, and uncertainty about how the Federal Reserve will handle interest rates moving forward have put credit markets in a tizzy, especially in private credit. But after spending more than 17 years overseeing commercial and consumer financial protections in California, I know well the distinction between genuine systemic vulnerabilities and stable lending structures — distinctions that appear to be omitted in recent criticisms of private credit that have permeated the news.

True systemic risk arises when institutions are unable to match their short-term liabilities with their assets, turning individual-firm problems into an industry-wide crisis. This situation is exacerbated when depositors can withdraw billions overnight while the institution's capital is locked in longer-term holdings. Take Silicon Valley Bank in California, for example. When the institution (holding massive concentrations of uninsured deposits) faced runs accelerated by digital technology and social media, the result was catastrophic, and SVB collapsed.

Private credit operates under a fundamentally different model. Business development companies, the primary vehicles for direct lending, are limited by law to a 2:1 leverage ratio. In contrast, the largest U.S. banks operate at ratios exceeding 12:1. Private credit funds rely heavily on maintenance covenants, whereas syndicated bank loans typically don't. Direct lenders hold loans to maturity, aligning their incentives with the borrower's financial health rather than with fees from loan syndication. 

The characteristics of private credit limit its risk profile, and other experts in finance agree. Federal Reserve Governor Lisa Cook, speaking at Georgetown University last November, stated clearly that she does not assess current risks from private credit as a threat to financial stability. She noted the sector "has the potential to enhance financial stability and expand economic growth, since it matches longer-maturity loans with longer-term funding." Cook emphasized unequivocally that private credit will not "contribute to an unexpected credit crunch in the same way that the asset-backed commercial paper market did in 2008."

And contrary to the view that private credit may spark a systemic crisis is the reality that the sector may, in fact, have prevented the last one. As one industry observer put it, in the aftermath of the 2023 banking crisis, "[private credit] probably lessen[ed] the overall impact to the economy compared to what would have happened if they weren't there."

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Private credit has grown, in part, because post-2008 banking regulations made it uneconomical for traditional lenders to serve certain borrowers. This has largely impacted the U.S. middle market, which comprises approximately 200,000 businesses that employ around 48 million people. Small manufacturers, local distributors, and minority-owned enterprises are the types of businesses that depend on reliable financing relationships designed to survive market volatility.

Private credit is well positioned to fill that void. The National Center for the Middle Market found that 72% of midsize businesses view private credit as important to achieving their growth objectives. The appeal comes from flexibility and aligned incentives. When your lender holds your loan to maturity rather than syndicating it, you get patient capital and fewer surprises when conditions shift.

Private credit has also already supported key investments into our nation's infrastructure. In California, a $200 million lending facility funded a 260 megawatt-hour energy storage project, providing grid resilience to low-income communities at risk from wildfires. The ability to craft bespoke financing arrangements makes private credit viable for projects that don't fit conventional banking approaches, whether due to project scale, timeline or risk profile. When standardized bank products won't work, private credit can step in with lending that fits complex projects.

Using recent market activity or bankruptcies to indict an entire asset class misreads both the evidence and the role of private credit in the broader economy. Private credit's structural safeguards, including lower leverage caps, tighter covenants and patient capital, limit systemic exposure while financing the businesses that traditional lenders may not be able to support. Confusing the attributes of this sector for risks will hinder economic growth, choke off capital to businesses with no alternatives and dry up funding for infrastructure projects that underserved communities desperately need.

It's worth stepping back from the media noise. Private credit isn't a risk waiting to explode. It's another pillar supporting the American economy.