Private Credit Boom Raises Concerns Among Regulators Amid Surging Leverage and Opaque Risks

The private credit market has transformed from a niche corner of finance to a global powerhouse, now valued between $1.3 trillion and $3 trillion. Born in the aftermath of the banking crisis, this sector rapidly filled the void abandoned by conventional lenders constrained by stricter capital requirements. Today, private credit attracts institutional investors seeking stable returns, with total yields of 8 to 10 per cent per annum not uncommon. Capital is typically committed for periods up to nine years, spread across dozens of leveraged buyout deals, extending both the sector’s reach and its inherent risks.

This asset class has become especially prominent in the United States, but Britain now claims its place as the leading jurisdiction outside America, making up an estimated 10 per cent of the world market. Blackstone, Apollo, and KKR headline the largest providers, supported by specialist houses like Ares and home-grown players including Intermediate Capital Group, M&G, Permira, and Bridgepoint. Legal and General has recently reinforced its presence through a significant stake in Pemberton and an alliance with Blackstone. Britain alone accounts for about two thirds of the $250 billion private credit market across Europe.

Borrowers, despite the flexibility private credit offers, often face interest rates at least 1.5 percentage points higher than those on conventional syndicated loans. The flexibility to overlook covenant breaches and the speed of negotiation—dealings with a single lender—are often cited as major draws, though these come at a price. The risk tolerance of private credit lenders runs higher, which has emboldened some to extend loans up to ten times a company’s earnings, relaxing previous lending and documentation standards.

Regulators, led by the Bank of England’s governor Andrew Bailey, now view this expansive lending activity with unease. Their concerns focus on rising leverage and the potential instability stemming from the sector’s interactions with banks and insurers. Although private credit funds draw from long-term, committed capital rather than relying on depositor funds, ties to the banking sector remain. Banks still provide bridging finance, invest in private credit funds, and maintain various forms of partnership, blurring the boundaries between traditional and new age lending.

Areas of particular worry include the rise in payment-in-kind notes, allowing borrowers to roll up interest into principal, as well as greater tolerance for junior debt. These structures increase the vulnerability of lenders, especially if poorly drafted loan documentation causes them to slide down the creditor hierarchy. Cases like Toys R Us, Chrysler, Asda, and Morrisons highlight the dangers that excessive debt can spell for buyout-backed companies, often with drastic consequences surfacing only after private equity owners have exited.

As more capital chases deals, competitive pressures threaten to erode lending standards further. The distinction between private credit and bank finance continues to diminish, prompting some to question whether risk is simmering beneath the surface. There is a risk that confidence in asset values is sustained through secondary deals and continuation funds, rather than open market price discovery. Over time, the persistence of so-called zombie companies may result in misallocated capital and hinder broader economic productivity, posing a distinct, if not systemic, challenge to the financial system.