Shifting Risk from Regulated Banks to the Private Credit Sector: Assessing Investment Risks and Opportunities in the Evolving Leveraged Loan Landscape

The financial landscape has undergone a seismic shift in recent years, marked by a rapid transfer of risk from traditional banks to the private credit sector. This migration, driven by regulatory constraints, macroeconomic pressures, and structural changes in capital markets, has redefined the dynamics of corporate financing and investment risk. As private credit expands to fill the void left by retreating banks, investors must navigate a complex interplay of opportunities and systemic vulnerabilities.

The Rise of Private Credit: A Structural Shift

The private credit sector has surged from $1.5 trillion in 2024 to an estimated $2.6 trillion by 2029, outpacing traditional bank loan growth by a significant margin according to Morgan Stanley. This expansion reflects a deliberate shift in risk provision, as post-2008 regulations have constrained banks' lending capacity, particularly in the middle market. According to the Federal Reserve, bank lending to private credit vehicles alone ballooned from $8 billion in 2013 to $95 billion in 2024. This trend accelerated after the 2023 regional banking crisis, exemplified by the collapse of Silicon Valley Bank, which forced corporations to seek alternative financing in private markets.

The structural shift is not merely a response to regulatory pressures but also a reflection of evolving investor demand.

Private credit offers attractive yields, often exceeding those of public leveraged loans, and provides access to a broader range of borrowers, including smaller, less liquid companies according to JPMorgan. However, this growth has raised concerns about the concentration of risk in a sector historically characterized by limited transparency and regulatory oversight.

Risk Profiles: Private Credit vs. Traditional Bank Loans

While private credit has demonstrated resilience in terms of returns, its risk profile diverges significantly from that of traditional bank leveraged loans. Private credit loans typically exhibit higher credit risk, with many borrowers operating at interest coverage ratios of 2x or lower-a threshold that has become increasingly common as economic conditions tighten. In contrast, bank leveraged loans are often issued to larger, more established firms with stronger balance sheets and are more liquid, as they are frequently syndicated and traded in secondary markets according to Lord Abbett.

Default rates for both asset classes remain within historical averages, with the leverage loan default rate at 4.31% by number of issuers as of March 2025 according to Hamilton Lane. However, private credit's risk profile is amplified by weaker covenants, higher leverage, and a lack of standardized reporting. A report by Lord Abbett notes that private credit's growth has been fueled by a transfer of risk from banks to asset managers, with private credit loans increasingly resembling broadly syndicated loans in terms of borrower characteristics according to Boston Fed.

Liquidity is another critical differentiator. Bank loans offer greater flexibility for investors, enabling them to adjust capital calls in private credit markets and enhance portfolio efficiency according to SSGA. Private credit, by contrast, is inherently illiquid, requiring long-term commitments and limiting investors' ability to respond to market shocks. This illiquidity, combined with the sector's rapid growth, has prompted regulators to scrutinize its potential systemic implications.

Investment Strategies and Portfolio Allocation

For investors, the evolving leveraged loan landscape demands a nuanced approach to risk management and diversification. Leveraged loans, with their seniority in capital structures and historical resilience during inflationary periods, remain a cornerstone of fixed-income portfolios. As of June 2025, leveraged loans offer yields near the 70th percentile of the past decade, with spreads over high-yield bonds well above the 10-year average according to SSGA. Their low interest rate sensitivity and strong risk-adjusted returns make them particularly appealing in a high-inflation environment.

Private credit, while riskier, offers complementary benefits. A strategic allocation of 5–20% to private credit within a private investment portfolio is often recommended, depending on an investor's risk tolerance and liquidity needs. Diversification across segments-such as direct lending, GP/LP solutions, and asset-backed credit-can mitigate idiosyncratic risks while enhancing returns. However, investors must remain vigilant about macroeconomic vulnerabilities, particularly in lower-quality private credit segments, where defaults could escalate during downturns.

The narrowing yield differential between private credit and leveraged loans also warrants attention. Increased competition and capital inflows have eroded private credit's traditional yield premium, reducing its relative appeal according to SSGA. This trend underscores the importance of rigorous due diligence and active portfolio management to capitalize on the sector's strengths while mitigating its weaknesses.

Conclusion: Balancing Opportunity and Risk

The shift of risk from regulated banks to the private credit sector represents both a transformative opportunity and a systemic challenge. While private credit's growth has been driven by legitimate demand for yield and flexibility, its structural vulnerabilities-limited transparency, concentrated risk, and regulatory gaps-pose significant challenges for investors and policymakers alike.

For investors, the key lies in adopting a balanced approach that leverages the strengths of both asset classes. Leveraged loans provide liquidity, diversification, and historical resilience, while private credit offers access to high-yield opportunities in the middle market. However, the rapid expansion of private credit necessitates heightened scrutiny of credit quality, liquidity management, and macroeconomic risks. As the sector continues to evolve, a disciplined, diversified strategy will be essential to navigating the shifting landscape of leveraged finance.