Core Concepts: The Evolution of Private Credit and What It Means for Banks

Historically a niche industry that served distressed borrowers with creative structures, private credit has evolved into a segment that also serves borrowers with products resembling traditional bank loans. This new focus has helped private credit to grow exponentially.  The private credit market is widely estimated to have hit the $2 trillion mark in 2025 and is expected to continue its rapid rise. With the Federal Reserve Bank of Boston expecting a $3.5 trillion total by 2028, private credit is often seen as a serious threat to traditional banks that are already facing fierce competition from credit unions and fintechs. Meanwhile, some regulators have expressed concern about the potential systemic risks of such a sizable sector. But the big picture can be  nuanced. It’s also the case that private credit firms can act as a safety valve for their bank competitors, purchasing stressed/distressed loans from them and offering capital relief to their borrowers, making at times for something more like a strategic coexistence.

Private Credit vs. Private Equity

Many are familiar with private equity, where sophisticated investors pool resources to invest in companies that are not publicly traded. With private credit, investors provide debt financing without staking any ownership claim. While this relationship limits private credit providers from influencing a borrower’s business decisions, it also allows them to avoid lender liability risks. A private credit deal is also less risky to the funding source than private equity. The funding sits higher in the capital stack that determines the order of who gets repaid among a company’s stakeholders, and is often secured by collateral. And the returns for lenders and investors can put private credit in a sweet spot, providing a premium above high-yield bonds and threatening less risk—albeit promising smaller returns as well—than private equity funding. These attractive and fairly reliable yields are part of the reason for the increasing popularity of private credit funds as alternatives to stocks and bonds.  

Private credit firms often target so-called “unbankable” companies. Despite the market’s movement into more traditional lending, many private credit deals still go to borrowers deemed too risky for banks due to factors such as high leverage, a limited operating history, regulatory restrictions, and credit policies. It’s not uncommon, for example, for private credit firms to provide bridge financing in the commercial real estate space when banks are not willing to extend a maturing loan on the same property. These deals allow borrowers to find bona fide refinance sources. Once these credits stabilize, borrowers are known to seek funding once again from a traditional lender.

 When Private Credit Is a Banker’s Foe

 In addition to borrowers who are forced to turn to private credit, some companies choose it  over available bank financing because of flexibility in terms, advance rates, loan-to-value limits, and covenants. Private credit deals may also allow for payment-in-kind interest. This creates a difficult choice for banks that want to compete. Banks that consider loosening lending standards could face a reckoning in the form of a higher rate of non-performing loans. Borrowers are also appreciate that private credit suppliers are often “flatter” than banks with rigid hierarchies and bureaucracies. This results in the ability to turn around loan approvals quickly, a critical advantage in today’s fast-paced business environment.

Closing Thoughts

Banks cannot, and should not, mirror private credit’s risk appetite given their deposit-funded model. Nor can they rely on lawmakers to curb competition through regulations. While some banks go head-to-head with private credit, others may choose to coexist, allowing it to take on the risky thickets of the financial forest while banks cultivate stable ground for prime borrowers.

In the meantime, strategic partnerships are emerging. Some banks have purchased interests in private credit funds. Others provide financing to them, with the Federal Reserve putting the number at $95 billion in  2024. Regulators have expressed concern about the risks of private credit funds lacking discipline or equity to support their loans in a downturn. The Financial Stability Oversight Council (FSOC), for one, warns that interconnectedness between private credit firms and the banks that fund them via warehouse lines could create a feedback loop—distressed loans cycling back to banks if these funds default,  reintroducing toxic assets to bank balance sheets. Sensible policies, such as stress testing banks’ exposure to private credit funds, could mitigate the risks without stifling the benefits of this coexistence.

Jason Alpert is managing partner at Castlebar Holdings, a distressed debt fund and financial institution advisor. Jason led and managed workout and special asset teams at major financial institutions for two decades. He is on the editorial advisory board of The RMA Journal and is an adjunct professor at the University of Tampa. Email Jason at jason@castlebarholdings.com or reach out to him at 813-293-5766.