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What began as a modest lending alternative for middle-market companies has ballooned into a financial behemoth. Private credit—a form of non-bank lending that operates outside the traditional regulatory framework—has surged to a staggering $1.7 trillion in assets under management as of mid-2025, according to data from Preqin and the Alternative Credit Council.

But as the sector’s meteoric rise reshapes modern finance, a growing number of analysts, regulators, and investors are sounding alarms about the risks that could be quietly building beneath the surface.

From Shadow Lending to Mainstream Powerhouse

Private credit refers to loans extended by non-bank institutions—such as asset managers, private equity firms, and hedge funds—to companies that might struggle to access funding from traditional banks. The industry’s appeal skyrocketed after the 2008 financial crisis, as stricter banking regulations forced commercial lenders to pull back from higher-risk borrowers.

Today, private credit funds have become dominant players in corporate lending markets, often offering quicker deal execution and more flexible terms than banks. According to BlackRock, the sector grew by more than 20% annually over the past three years alone, fueled by institutional investors hunting for higher yields in a low-interest-rate world.

But with that rapid growth comes new vulnerabilities.

Systemic Risk Warnings Mount

Economists and policymakers warn that the sector’s opacity, combined with looser underwriting standards, may be planting the seeds of a future financial crisis. Unlike traditional banks, private credit funds are not required to hold capital buffers or undergo regular stress tests. This lack of oversight has regulators worried about how these lenders would perform during a severe economic downturn or a liquidity crunch.

One of the chief concerns involves the rising use of paid-in-kind (PIK) loans—a financial instrument that allows borrowers to pay interest with additional debt instead of cash. While this feature can help struggling companies stay afloat, it also risks masking real financial distress.

“When you start seeing more PIK loans and overly generous lending terms, it’s a signal that lenders may be prioritizing growth over prudent risk management,” said Sheila Bair, former FDIC Chair, in a recent panel discussion hosted by the Brookings Institution.

Who’s Most Exposed?

Middle-market companies, often backed by private equity sponsors, are among the biggest users of private credit. These firms typically operate with high leverage, and when credit conditions tighten or revenue falters, they can quickly become vulnerable to default.

According to Moody’s, the average debt-to-EBITDA ratio of companies borrowing in the private credit market is now nearing 6.5x—well above historical averages. Defaults in the space remain relatively low for now, but watchdogs worry that could change fast in a recessionary environment.

Institutional investors—such as pension funds, insurance companies, and endowments—are also exposed. Many have shifted billions into private credit in search of stable returns, often underestimating the liquidity risks and hidden leverage in their portfolios.

Calls for Greater Transparency and Oversight

The International Monetary Fund (IMF) and Bank for International Settlements (BIS) have both called for stronger oversight of the sector. In its 2025 Global Financial Stability Report, the IMF warned that the size and interconnectedness of private credit could “amplify shocks” in global markets if left unchecked.

“There is a growing disconnect between the size of private credit markets and the regulatory tools available to monitor or intervene in times of stress,” said Tobias Adrian, Director of the IMF’s Monetary and Capital Markets Department.

The U.S. Treasury's Financial Stability Oversight Council (FSOC) has reportedly begun informal talks about enhanced reporting requirements and closer supervision of larger private credit firms that pose systemic risk.

The Bottom Line

While private credit has undoubtedly filled an important gap in post-crisis financing—and offered impressive returns in a yield-starved world—it may now be reaching a dangerous inflection point. As investor appetite continues to push the industry past $1.7 trillion, the lack of transparency and rising use of exotic loan structures like PIKs could set the stage for future financial instability.

Whether regulators can act swiftly and effectively to monitor and manage these risks remains an open—and increasingly urgent—question.