Abby Medin, Stanford University
Private credit represents a necessary evolution of capital markets, improving efficiency and access to financing– but only with transparency and effective risk management. Public markets have traditionally been an important way for the broader population to reap the benefits of economic growth, whereas private markets are closed transactions strictly between lenders and borrowers. However, through innovative lending, private credit offers more opportunities for firms to grow as they become more accessible and integrated into the broader economy.
Over the past decade, private credit has transformed from a niche alternative strategy into a mainstream pillar of modern capital markets. Once overshadowed by traditional bank lending and public debt, private credit funds now play an increasingly important role in financing middle-market companies, supporting business growth, and filling structural gaps left by the regulated banking sector. Increasingly, private investments are becoming more accessible and mainstream. For example, the U.K. recently launched its Private Intermittent Securities and Capital Exchange System (PISCES) that enables private company shares to be traded in the secondary markets. It offers liquidity via scheduled, intermittent, or periodic auctions rather than continuous trading like traditional exchanges, but still serves as a promising way to help firms stay private longer by providing liquidity for early investors and employees. While private credit differs in that it trades private company debt, PISCES still demonstrates the growing retail accessibility and momentum surrounding private market investing.
At its core, private credit refers to non-bank lending, typically provided by asset managers to companies that may lack access to public debt markets. Asset managers are financial professionals who handle clients’ investments to grow their wealth. They work on behalf of pension funds, endowments, firms, and individuals. Private credit loans are often customized, privately negotiated, and held to maturity. The growth of this market did not occur by happenstance. Following the global financial crisis in 2008, tighter bank regulations significantly constrained traditional lending. Capital requirements rose, risk tolerance fell, and banks increasingly retreated from middle-market and more specific financing. Only bigger and more stable enterprises could secure loans and services from the newly intensely risk-averse banks. Private credit stepped in not to replace banks entirely, but to complement them—absorbing demand that the regulated system could no longer efficiently serve. Low interest rates in the 2010s further pushed asset managers to search for higher-return alternatives, which helped drive growth in private credit investing, offering higher returns than the public market.
Since its rise, private credit has ballooned into many different forms including traditional direct lending, second lien debt, distressed debt, special situations, and asset-based finance. Traditional direct lending involves private debt funds and business development companies lending to middle-market companies through senior secured loans, which are loans that ensure lenders are first in line for repayment.
Second lien debt, however, is secured by the same assets or collateral as another loan, but has a lower payment priority. If a borrower defaults, then the first lienholder gets paid in full before the second lienholder can receive any money. A common example of second lien debt is junior mortgages, where borrowers take out a second loan to cover the downpayment of buying a house. These types of loans are higher risk for lenders, because they are less likely to be paid back given the priority. Hence, second lien loans often charge higher interest rates to compensate for this risk.
Distressed debt is a blanket term for any bonds, loans, or other financial obligations experiencing significant financial distress, insolvency, or bankruptcy. Due to the high risk of default, these securities trade at huge discounts compared to their original price. Investors often buy these securities for the possibility of a turn-around or aim to take control of the company through bankruptcy proceedings.
Special situations investing revolves around the speculation or expectation of non-routine corporate events. These events include mergers and acquisitions, spinoffs and demergers, or other types of restructuring. The goal is to profit off of overvalued or undervalued assets affected by these complex events. However, because these investments are driven by specific events rather than market sentiment, they carry large downside risk if the event fails and are often based on limited information.
Asset-based finance is a type of lending where loans are secured by income-generating assets instead of a company’s basic cash flows. These assets could include real estate, future receivables, royalties, mortgages, auto loans, or credit card debt, etc. This allows businesses and consumers to obtain diversified funding and provide alternative investors a way to earn returns outside of the stock market.
All of these types of investments are considered private credit. Therefore, private credit covers a broad, heterogeneous category of debt markets, making it harder to determine specific risks and market trends.
Nevertheless, private credit has historically outperformed the market, even adjusted for increased risk. Private credit loans are floating-rate, meaning the loans adjust to current interest rates. Hence, private credit tends to outperform in rising-rate environments. Rates rose in 7 periods following 2008, averaging 11.6% returns, 2% above its long-term average.
Source: Private Credit Outlook: Estimated $5 Trillion Market by 2029 | Morgan Stanley
While many criticize private credit for risky and questionable lending, private credit can offer better risk management against losses. It’s true that privately held companies often do not have credit ratings, and if they did, would probably be below investment grade.
To combat this, traditional private credit uses “maintenance covenants”, which are limits on the amount of debt or loans firms can have. When a borrower breaches these limits, a lender can ask for an equity injection from shareholders or private equity owners, force them to sell assets, or demand more collateral. An equity injection is where borrowers must directly contribute personal, unborrowed cash, or assets into a project or business acquisition, which is aimed to prevent moral hazard by increasing the amount of stakes borrowers have in their loans. Therefore, direct lending can be more transparent and proactive about negotiating lending as opposed to broader leverage financing in the financial industry, leading to decreased credit losses as demonstrated by the chart below.
Source: Private Credit Outlook: Estimated $5 Trillion Market by 2029 | Morgan Stanley
One of private credit’s most compelling advantages is flexibility. Unlike public debt, which is standardized and market-driven, private credit allows lenders and borrowers to tailor terms to specific business needs. This flexibility can be particularly valuable for mid-sized firms navigating expansion, acquisitions, or cyclical volatility. For many of these companies, private credit is not a last resort—it is the most efficient form of capital available.
From an economic perspective, this customization improves capital allocation. Rather than relying on rigid credit models or one-size-fits-all covenants, private credit lenders conduct intensive due diligence and structure loans that reflect firm-level fundamentals. In theory, this should reduce mispricing of risk and allow productive firms to access financing even when they do not fit neatly into public-market benchmarks. This increases overall market efficiency, providing benefits for the entire economy.
However, this flexibility and efficiency comes at the expense of transparency and disclosure to regulators and investors, which can lead to moral hazard, excessive risk, and opacity problems. Recently, investors have engaged in a massive selloff of private credit investments, prompted by anxiety about the true value of assets that remain ambiguous without the constant pricing and disclosure that takes place in private markets. The Cliffwater Corporate Lending Fund transparency has been described as “Imagine opening a black box, only to find 5,000 more black boxes inside.” Without proper knowledge of all listed borrowers, and layers of leverage, investors find themselves ambiguous to what the shares are actually worth. This presents concerns for the increasing number of retail private credit investors, who may not realize the level of risk they are undertaking.
In addition, banks themselves have become increasingly engaged in the world of private investments –$300B in exposure to private credit– removing the diversification and independence of private sector investments that often hold larger risk than traditional investments. Private credit now spans multiple industries and pension funds, presenting deeper systemic risk and interdependence.
Private credit is not a substitute for bank lending—it is a fundamental reallocation of financial risk born by traditional lenders. By expanding access to capital and tailoring financing to firm-specific needs, it has improved efficiency and supported economic growth. Yet, this progress comes with a tradeoff: risk is no longer concentrated in heavily regulated banks, but dispersed across opaque, interconnected networks of asset managers, pension funds, and increasingly, retail investors. Therefore, the same systemic vulnerabilities of 2008 were not eliminated by increased bank regulations, and live on through private credit lending, with even more ambiguity and less disclosure. As private markets become more accessible and integrated in the broader financial system, it is important to consider whether the institutions surrounding it have evolved quickly enough to monitor and manage the risks it introduces. Without greater transparency and disciplined risk oversight, private credit bores the same systemic risk as traditional lending and investing.