Private Credit: Growing Regulatory Concerns and the Risks for Financial Institutions – Part 1: Regulatory Risks

This article was first published in the October 2026 issue of Butterworths Journal of International Banking and Financial Law.

KEY POINTS

• Private credit has expanded rapidly prompting heightened regulatory scrutiny. Regulators warn that layered leverage and complex interconnections with banks, insurers and private equity could transmit stress across the financial system, while many banks struggle to aggregate and monitor these risks effectively.
• Key vulnerabilities include weaker borrower credit quality, limited transparency, subjective and opaque valuation practices and potential conflicts of interest. Liquidity mismatch and concentration risk are also rising as more private credit funds offer investor redemption rights and as exposures become concentrated in specific sectors. 
• The sector remains largely untested through a prolonged downturn which could trigger redemptions, forced asset sales and broader market spillovers affecting financial institutions.

ABSTRACT

Private credit has grown into a major source of financing, but its rapid expansion has attracted increasing regulatory scrutiny. Recent reports from the Financial Stability Board, IOSCO and the House of Lords identify concerns relating to leverage, opacity, interconnectedness and liquidity within the sector. This is the first article in a series of two, considering the regulatory and litigation risks arising in the sector. In this first article, focusing on the regulatory risks, we examine how these vulnerabilities, particularly borrower credit quality and valuations, liquidity mismatch and concentration risk, may affect financial institutions. We highlight the growing links between private credit, private equity, insurers and banks, and explore the legal and regulatory risks that may arise if these vulnerabilities crystallise during a period of prolonged market stress. Our second article will consider the growing litigation risks for financial services firms.

GROWING REGULATORY CONCERNS 

Private credit plays a core role in the functioning of private markets¹ and has become an increasingly important focus point for regulators² and legislators. Private credit (meaning, in the broadest terms, non-bank lending negotiated on a bilateral basis) has grown significantly since the 2008 financial crisis. The private credit market is estimated at between $1.5 trillion and $2 trillion as at end-2024, making it comparable in scale to both the institutional leveraged loan market and the high-yield public debt market.

While non-bank financial intermediation has been on the regulatory radar for a long time, the exponential growth in private markets has caused a growing clamour for regulators to understand and address the associated risks to the financial system. 

In May 2026, the Financial Stability Board (FSB) published its “Report on Vulnerabilities in Private Credit” (FSB Report).³ The FSB concluded that, despite the sector's genuine economic utility in providing financing to underserved borrowers, private credit remains untested through a prolonged economic downturn. The conditions now present in the market – concentrated borrower risk, compounding leverage, opaque valuations, and a web of interlinkages with regulated institutions – create a configuration of vulnerabilities that the FSB considers warrants close attention by regulators. The FSB Report echoes concerns identified by the International Organization of Securities Commission (IOSCO) in its 2023 report “Leverage, Liquidity and Other Financial Stability Risks from Private Finance Activities” (IOSCO Report),⁴ and the Financial Services Regulation Committee of the House of Lords ( FSRC) in its January 2026 report, “Private Markets: Unknown Unknowns” (FSRC Report).⁵

In this article, we consider whether the growing clamour is becoming more acute as concerns grow in light of the sector’s exposure to technology and disruption caused by AI in addition to reports of increased redemption requests. We first outline the connections between private credit funds and other financial institutions in the private credit ecosystem and then consider three key areas of concern identified in the FSB Report and analyse the associated legal and regulatory risks that financial institutions, in particular banks, should be aware of in the event that those risks crystallise:

1. borrower credit quality, valuation, and opacity;
2. liquidity mismatch; and
3. concentration risk. 

INTERLINKAGES, INTERCONNECTIVITY AND LAYERED LEVERAGE

The deepening interlinkages and interconnectedness between private credit and banks, private equity, and the insurance sector represents one of the most structurally significant features of the contemporary private credit landscape.⁶

Interlinkages with Banks

Banks sit within the private credit ecosystem in multiple capacities: 

• Providers of financing to private credit funds, corporate borrowers and investors in private credit; 
• Engagement in synthetic risk transfers (SRTs); and
• Investors in private credit collateralised loan obligations (CLOs) or providing warehouse financing to CLOs. 

The FSB Report notes that the resulting web of interlinkages may create challenges for banks in effectively managing their direct and indirect risks, especially where there is fragmented oversight within banks of these different interlinkages.⁷

The FSB's “Global Monitoring Report on Non-Bank Financial Intermediation” identifies direct, indirect, and structural linkage as the three principal channels through which bank and non-bank interconnectedness transmits stress:⁸

In terms of direct exposure to private credit funds, the principal financing channels include subscription lines (the most common form), fund portfolio financing and borrowing-base facilities, Net Asset Value (NAV) facilities, asset-based lending, repo/collateralised financing, and involvement in private credit CLOs including warehousing and tranche purchases.⁹ A common exposure arises where banks provide revolving credit facilities to the same companies that borrow from private credit funds; one study estimates this overlap at approximately half of private credit borrowers, creating common exposures and concentration of credit risk that can crystallise simultaneously across both the fund and the bank's corporate lending book in a stress event.¹⁰

The cumulative “layering” of debt across portfolio companies, private credit funds, and investor financing, has been identified as a system wide vulnerability¹¹ but, according to evidence submitted to the FSRC, the precise scale of this risk is challenging to accurately assess because of the complexity in funding and deal structures, and the absence of public financial information.¹²

SRTs represent a particularly complex interlinkage. Banks sell a significant share of SRT instruments to private credit funds,¹³ and the FSB Report warns of potential "circles of risk" where banks fund the same non-bank entities that then absorb credit risk transferred from those banks – increasing leverage and feeding risk back to the banking system in a circularity that is difficult to monitor given data fragmentation across the intermediation chain.¹⁴

From a supervisory perspective, the Prudential Regulation Authority's (PRA) April 2024 Thematic Review of Private Equity-Related Financing Activities (PRA Thematic Review) provides an overview of risk management challenges that banks can face. The PRA’s findings included the following:¹⁵

• many banks cannot uniquely identify and systematically measure combined private equity-linked credit and counterparty exposures within their overall risk data; 
• the typical organisational arrangements of independent credit and counterparty credit risk management oversight do not readily support the effective risk management of combined PE linked credit exposures generated across separate business units; 
• there are potential scenarios where the risk of loss through unforeseen credit and counterparty risk correlations may increase;
• many banks do not calculate comprehensive consolidated exposure data to measure and control combined private equity credit and counterparty risks that are directly and indirectly linked to individual financial sponsors, and lack risk appetite frameworks that constrain combined exposures linked to individual financial sponsors; and 
• overlapping financial claims are frequently not identified or aggregated, leading to the risk that banks may underestimate their risk of loss due to overlapping and linked credit exposures should multiple private equity portfolio companies suffer distress.¹⁶

Insurers and private credit funds

Insurers and pension funds are significant investors in private credit, attracted by illiquidity premia and long dated cashflows consistent with their investment mandates.¹⁷  However, as the FSB Report notes, these investments may involve significant trade-offs, including reduced liquidity and increased valuation challenges, particularly during periods of market stress.¹⁸

Partnerships between life insurers and private credit investment firms have created structures that seek to shift portfolio allocations towards riskier corporate debt, importing susceptibility to risks surrounding flexibility and opacity in valuations (discussed below in this article).¹⁹

Ownership of insurers and private credit funds 

The interconnection is further compounded by a growing trend of private equity firms acquiring life insurers and reinsurers or engaging in funded reinsurance arrangements. Private equity firms are "leveraging life insurance liabilities as a stable, long-term funding source to invest in private credit and structured products" and where the private equity-owned insurer invests in structured securities, in some cases they are managed by the private equity sponsor itself.²⁰

Private equity-backed insurers in the US now control approximately $900 billion in insurance liabilities – a significant increase from $67 billion in 2012 – with 35% of new US annuity sales in 2023 going to private equity-backed insurers.²¹

Concurrent private credit and private equity involvement 

Another dimension to this interconnectedness is the relationship between private credit and private equity. Private credit often provides the debt financing for private equity transactions – particularly leveraged buyouts – and many large alternative asset managers operate both private equity and private credit strategies under the same roof, creating potential conflict of interest concerns.²²

As noted by IOSCO, where a single group operates both private equity and private credit funds (which finances the private equity fund's portfolio companies) the interests of equity and debt holders may diverge materially, particularly in stressed scenarios. For example, a firm may exercise debt holder rights in a manner that supports its equity position, potentially to the detriment of other debt holders.²³

BORROWER CREDIT QUALITY, VALUATION AND OPACITY 

Borrower Credit Quality

Private credit has historically focused on unrated companies whose credit fundamentals resemble high-yield corporate credit, including medium sized companies that are highly leveraged.²⁴ Where such borrowers have ratings, they appear to be concentrated around the single B credit rating bucket. Compared to public markets, these borrowers tend to be smaller, with some estimates indicating approximately 75% of borrowers having EBITDA below $100 million.²⁵

This borrower-level fragility is compounded by the opacity of the borrower base. As most borrowers are private companies and private credit regulation is light touch, there is limited disclosure and data availability which constrains the ability of private credit funds, banks and regulators to assess borrower leverage and financial resilience. This in turn can amplify credit-related vulnerabilities.²⁶

A related concern is the opacity of the private ratings ecosystem. Managers of private credit funds seek private ratings primarily to facilitate co-investments with insurers, but these ratings are not publicly disclosed.²⁷ The FSB Report flags growing reliance on smaller, lesser-known agencies to provide private credit ratings, accompanied by reports of ratings inflation.²⁸ Drawing on evidence by the International Monetary Fund, the FSRC Report suggests that ratings inflation may not only distort the pricing of risk but the regulatory capital buffers maintained against it (as the UK insurance industry relies on the use of ratings as part of the matching adjustments for regulatory capital requirements).²⁹ 

Leverage amplifies the risk emanating from borrower credit quality. Private credit borrowers exhibit leverage at approximately 5-6x debt-to-Earnings-Before-Interest, Taxes, Depreciation, and Amortization (EBITDA), higher than the approximately 4x observed in leveraged loans.³⁰ The widespread use of EBITDA adjustments may further understate headline leverage such that the true leverage position could in fact be closer to 7x.³¹ The FSB Report cautions that this raises concerns about the level of risk in the market and potential misalignment with pricing.³²

Valuation staleness, discretion, and structural bias 

Private credit valuations are updated infrequently, often on a quarterly basis and are typically based on two approaches, an income approach and a market approach based on comparable peers.³³

Though the pace of valuations may be indicative of the general “buy to hold” nature of private finance investments, both the FSB Report and FSRC Report suggest that such valuations result in reported values adjusting slowly and may not immediately reflect market conditions,³⁴ particularly in stressed environments. In this regard, IOSCO notes that there is usually a two to three quarter lag between a decline in public market valuations and the impact becoming fully evident in private markets.³⁵

The valuation process involves an element of subjectivity. The income-based approach in particular may incorporate practices that grant managers significant discretion. Indeed, even with the purest of intentions, discrepancies in valuations will naturally arise across managers as a consequence of subjective judgment being exercised.³⁶

The subjectivity embedded in this process creates a structural conflict of interest. Managers may have potential incentives to manage valuations in a way that minimises the appearance of volatility, by delaying or spreading out the impact of negative shocks that could reduce asset values.³⁷ Drawing on evidence from the Financial Conduct Authority (FCA), the FSRC highlighted the potential conduct dimension to this structural concern. A decrease in fund valuation can ultimately lead to a reduction in management fees, potentially discouraging appropriate write-downs.³⁸ A further conflict arises in fund-level borrowing where collateral values are assigned by the fund itself – inflated valuations could increase borrowing capacity or allow funds to avoid loan-to-value covenant breaches.³⁹

Valuation practices have been a focus point for the FCA which conducted a multi-firm review into private market valuation practices in 2024 and reported its conclusions in 2025.⁴⁰ While the FCA identified examples of good practices, it also identified several key areas where firms needed to improve. This included where firms had only partially identified and documented potential conflicts, most notably with gaps in relation to valuation-related conflicts related to investor marketing, secured borrowing, asset transfers, redemptions, subscriptions, uplifts, and volatility. There was also found to be variable levels of independence within valuation processes/functions, and a lack of process and consistent approach in relation to ad hoc valuations to revalue assets during market or asset-specific events.

Conflicts of interest lie at the core of the FCA’s concerns and therefore, as part of its next multi-firm review, it has been looking at how these are managed in private markets. The FCA has already gathered information about how firms identify conflicts and design their frameworks and is now focused on reviewing how they operate in practice. Its findings are expected to be published later in 2026.

Due diligence and disclosures 

The opacity of the borrower base naturally leads to challenges when it comes to private credit funds conducting due diligence on borrowers and making appropriate disclosures to both investors and lenders.

The FCA’s case against H2O AM LLP (H2O)⁴¹ provides a clear example of how poor due diligence can lead to regulatory enforcement. Between April 2015 and November 2019, H2O managed a series of funds that invested heavily in high-risk, illiquid bonds linked primarily to the Tennor Group and entities connected to financier Lars Windhorst, without conducting adequate due diligence or properly managing the associated risks and conflicts of interest. These exposures grew significant and concentrated, and when concerns emerged publicly in 2019, they triggered large investor redemptions, ultimately leading in 2020 to the suspension of several funds due to liquidity and valuation issues, leaving investors unable to access billions in assets. The FCA found that the firm had carried out little, if any, due diligence into the underlying Tennor Group companies, and had later tried to fabricate such evidence in order to respond to the FCA’s queries.

Where there are disclosure failures, there is very likely to be an associated regulatory risk. This is because disclosures are, in general terms, required to be clear, fair and not misleading, and a failure to meet this standard (whether through inaccuracies or omissions) will clearly carry enforcement risks.⁴²

LIQUIDITY MISMATCH

Moving from closed to open-ended to attract investors

The conventional way private credit funds mitigate against the risk of liquidity mismatch is the closed-ended fund model. Capital is locked in for the life of the fund and assets and liabilities are broadly matched. However, the private credit market is evolving to attract a broader investor base. In the euro area, around 20% of private credit funds are now open-ended, with approximately 75% of those allowing monthly or more frequent investor redemptions. In the United Kingdom, whilst most funds continue to be closed-ended, there has been a noticeable growth in semi-liquid and evergreen structures offering periodic redemption windows.⁴³

The FSB Report cautions that liquidity mismatch risks may increase going forward if managers continue to offer more flexible redemption terms to attract investors, particularly retail investors.⁴⁴ Retail investors may not fully understand the illiquidity of the asset class, which may amplify redemption requests during stress episodes.⁴⁵ There is evidence that this risk has already started to crystalise in some quarters. Several private credit funds were reported to have received large redemption requests – in excess of applicable stated withdrawal limits, reported for some funds as 5% of NAV – particularly from high-net-worth investors.⁴⁶ Some managers met these requests by applying withdrawal limits, a practice the FSB Report notes may itself stimulate further redemption pressure by signalling that investor demand for exit is high.⁴⁷

The FSB Report also identifies a means by which risk can transfer to the banking system. Private credit funds' reliance on bank credit lines for liquidity could shift pressures to banks, especially if corporate borrowers simultaneously draw on revolving credit facilities. Institutional investors, such as insurers and pension funds, may also face capital calls that force sales of liquid public assets, increasing the risk of correlated stress across markets.⁴⁸

Suitability

The IOSCO Report highlighted that some industry analysts have suggested that fund managers may be looking to retail investors to fill funding gaps left by retreating institutional investors, meaning retail investors could be exposed to higher than appropriate levels of risk.⁴⁹ Clearly, where retail investors are involved, in addition to the risks relating to disclosures, suitability risks arise.

Where retail investors suffer financial losses from their private credit investments, or become trapped in funds that only hold illiquid assets that are difficult to sell, there is a risk that they, or regulators, may claim that they did not understand the risks associated with the investment, and that the recommendation or advice they received was unsuitable. 

Liquidity management 

Where open-ended structures are used, the importance of liquidity risk management comes to the fore, particularly for private credit funds where the underlying assets tend to be illiquid in nature. 

There are multiple cases where the FCA has taken action against firms for failing to exercise appropriate risk management – including the cases against Neil Woodford and Woodford Investment Management.⁵⁰ Between July 2018 and June 2019, the Woodford fund sold more liquid investments and bought illiquid investments. The fund’s value fell from a high of over £10.1bn in May 2017 to just £3.6bn in the run-up to its suspension in June 2019. By the time of suspension, only 8% of the investments could be sold within 7 days whereas investors should have been able to access their funds within 4 days. 

The FCA found that the funds liquidity profile was unreasonable and inappropriate as a result of the investment decisions taken by the manager, and they did not react appropriately as the fund’s value declined, its liquidity worsened and more investors withdrew their money. The decision to suspend was made too late to the detriment of investors that were late movers and were effectively trapped in the fund with only its most illiquid investments remaining. This disadvantaged investors who remained in the fund, compared to those who had withdrawn their investment before the fund was suspended. 

CONCENTRATION RISK

Concentration risk in private credit operates at multiple levels simultaneously, across borrower sectors, asset managers, and bank lenders. Its significance is compounded by the data limitations that make it difficult for regulators to observe and monitor in real time.

Private credit loan originations remain concentrated in a small number of industries, principally technology, healthcare, and services. This creates a trade-off between specialisation and diversification and exposes portfolios to the risk of idiosyncratic, region or industry-specific shocks.⁵¹ The FSB Report highlights the sector's growing exposure to technology and artificial intelligence (AI) infrastructure, with $800 billion of a projected $2.9 trillion in AI capital expenditure (2025–2028) expected to be financed by private credit.⁵² This raises material concerns about vulnerability to AI disruption scenarios or an AI bust.⁵³ IOSCO echoes this concern, warning that concentrated sectors reliant on continuous affordable financing, such as technology and healthcare, face significant risk.⁵⁴

The concentration of bank lending to private credit vehicles is equally pronounced. The top five US banks account for 63% of total committed loan amounts to business development companies, and the top ten for approximately 84%,⁵⁵ meaning that the distress of even a single major bank lender could have disproportionate effects on fund liquidity across the market.

At the asset manager level, five large alternative asset management groups account for approximately one-third of aggregate loan commitments across the private credit and equity industry globally.⁵⁶ In the UK, the top five asset managers account for over 50% of gross assets in UK-managed private credit funds.⁵⁷

As noted above, the PRA highlights a governance weakness underpinning this risk: banks are often unable to identify and measure aggregate exposures linked to individual private equity sponsors, meaning correlated credit and counterparty risks are neither constrained by risk appetite nor adequately overseen at board level.⁵⁸ The FSB's work on Leverage in Non-Bank Financial Intermediation frames the systemic consequence – concentration and "crowdedness" are key amplification factors for financial stability risk because forced deleveraging into markets unable to absorb asset sales can generate cross-market spillovers, and concentrated exposures can threaten systemically important counterparties.⁵⁹ This may have severe consequences for any bank that has, unbeknownst to its risk functions and senior management, become exposed to such concentrated risk. Indeed, the PRA’s case against Credit Suisse⁶⁰ regarding its management of its exposure to Archegos Capital Management provides a clear example of how these concerns might play out in practice.  

CONCLUSION

The vulnerabilities identified in the FSB Report should not be read in isolation. They are structurally interlinked and reinforcing. The FSB's central concern is that limited visibility over concentrations and correlations impairs effective risk pricing, while leverage, interconnectedness, and illiquidity create channels for broader market spillovers. 

In a downturn scenario (triggered, for example, by persistent inflation, higher rates, or a sharp valuation correction in technology or AI-related assets), highly leveraged borrowers would experience sharp deterioration in debt service capacity, driving rising defaults. Opaque and infrequent valuations may delay and then compress loss recognition into a narrow window, crystallising first-mover dynamics that intensify redemption pressure, particularly in semi-liquid funds holding illiquid assets. 

Banks are often exposed simultaneously through multiple financing channels. They may find those exposures crystallising across business lines and geographies that their own data systems cannot reliably consolidate. A large increase in portfolio company defaults could lead a private credit fund to default on its debt, prompting it to sell assets at a discount, which could result in losses for investors, including institutional investors such as pension funds or insurance companies. If the losses are significant enough, these investors may need to sell other assets to meet redemption requests, potentially leading to forced selling in public markets.

The FSB conclusion is clear – private credit remains largely untested through a prolonged downturn, and that the combination of opacity, leverage, weaker borrower quality, and evolving liquidity dynamics creates a risk profile that warrants close monitoring. For financial institutions, these vulnerabilities have direct implications beyond prudential supervision. Should such risks crystallise, they will likely have legal and regulatory consequences that give rise to issues relating to due diligence, disclosure, conflicts of interest, valuation practices, and risk management.