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Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
The writer is senior fellow at the Hoover Institution and professor of finance at Stanford’s Graduate School of Business
Every few years, a new corner of the financial ecosystem is dubbed the next ticking time bomb. Now it’s private credit’s turn. Doomsayers point to recent drawdowns and the industry’s connections to traditional banks as evidence of an impending 2008-style collapse. Investor fear is self-reinforcing, especially since private credit offers less transparency than the traditional bank lending it has replaced. But the data tells a starkly different story about the asset class’s soundness than what’s in the headlines.
Gregor Matvos, Tomasz Piskorski and I examined roughly 1,300 private credit funds and nearly 9,000 underlying loans spanning the last quarter century — about two-thirds of the market. We found that private credit funds are built nothing like the institutions that have triggered past financial crises.
Start with leverage, the most important variable in determining whether a financial institution survives a downturn or sparks a crisis. Before 2008, the largest financial institutions were levered as high as 30-to-1. When home prices modestly declined, their thin equity cushions evaporated and failures cascaded through the system. Post-crisis reforms now force banks to hold more capital, limiting them to roughly 8-to-1 leverage, about 12 cents of equity for every dollar of assets, so even modest losses can quickly erode the buffer protecting depositors.
Private credit funds sit on a substantially stronger capital foundation. Our research found that total private credit fund assets typically carry a leverage ratio of roughly 1.25-to-1. Among funds that borrow from banks, roughly 65 to 80 cents of every dollar of assets is funded by equity rather than debt. A private credit fund can absorb enormous losses before creditors are meaningfully affected. Losses are borne first by long-horizon equity investors rather than short-term creditors, making private credit funds inherently more stable in the face of volatility or economic downturn.
Critics have also pointed to private credit’s connections to banks as a potential channel for destabilising shocks to flow into the broader financial system. Our research shows these linkages are modest. Private credit funds tend to borrow from banks through short-term credit lines for specific purposes, like managing the timing of capital calls, rather than as a source of persistent leverage. The Federal Reserve modelled what would happen to banks if a crisis rocked financial firms like private credit funds and forced full drawdowns on their credit lines. Big lenders remained well capitalised. The Fed’s conclusion was straightforward: private credit does not pose a systemic risk to the banking system even in a severe economic downturn.
Still, certain market watchers argue that an industry crisis is already upon us. Retail investors are scrambling for their money back. Funds facing the heaviest withdrawal pressure are limiting quarterly payouts to about 5 per cent of assets. These gates are creating heartburn for investors, but they exist precisely to prevent forced asset sales into thin markets at discount prices. When funds activate them, the system is working as designed — slowing stress rather than amplifying it.
This is structurally unlike banks, which fund long-term assets with short-term liabilities that depositors can withdraw on demand. That mismatch between when obligations come due and when assets can be liquidated is a structural fault behind many credit crises. Private credit funds face no such tension because capital remains committed well beyond the life of individual loans. Obligations and assets move on compatible timelines, significantly reducing the potential for forced mass liquidation.
There are legitimate questions about transparency. Valuations are often model-based rather than market-tested, which can obscure underlying asset quality in real time. That risk is real — not a sudden collapse, but a gradual tightening: if investors begin to question valuations or losses accumulate across funds, capital flows could slow, credit supply could contract, and stress could propagate indirectly through banks, insurers and pension portfolios.
We will probably see some private credit loans go bad in the months ahead. We will probably see some high-yield bonds do the same. That is what happens at the end of a credit cycle. But investors and regulators should be wary of overreacting to individual failures or conflating them with a systemic threat. The differences between private credit funds and the culprits of the last financial crisis are more instructive than their similarities. The real lesson is not that risk has disappeared, but that it has been redistributed.
