Private Credit: The Next Shadow Banking Hazard?

Chasse Rehwinkel served as the Chicago Comptroller from 2023 to 2025 and the Director of Banking for the State of Illinois from 2019 to 2023. Currently, he is the Chief Financial Officer and Executive Vice President of Devon Bank, as well as a lecturer on banking management and regulation at the University of Chicago-Harris School of Public Policy. 

In the United States, access to capital flows like a river, cutting across the countryside as it seeks the path of least resistance, inevitably finding the areas of lowest regulatory scrutiny. 

Sometimes this is consumer-positive — eliminating costly friction within the financial system, usually through technological advancement, to the benefit of everyday Americans. However, for every automated teller machine and debit card, there are innovations that reduce the overall transparency of leveraged cash flow in the economy. 

Private credit, the debt financing of private companies through non-bank lenders, has certainly met the standard of being an innovation, in that it removes a degree of regulatory transparency in the overall credit market. What remains to be seen is what level of risk will it create within the economy as a whole.

A Brief History of Shadow Banking

Private credit is the evolution of direct lending by non-banks — part of the shadow banking system.¹ Direct lending itself is not a new phenomenon within U.S. credit markets. In the 20^th Century, the Investment Company Act of 1940 introduced the regulatory foundation for private non-bank investment funds.² Research into corporate bond financing led by W. Braddock Hickman in the 1950s and 60s generated financing interest in speculative-grade business investment in the 1970s and 80s—so-called junk bond investing. In 1980, Congress amended the Investment Company Act of 1940 to allow for the creation of Business Development Companies (BCDs). BCDs are unregistered closed-end investment companies that specialize in extensions of credit to small and mid-sized businesses, and are overseen by the SEC. Further deregulation and an investment boom in the 1990s set the table for the institutions that dominate private credit today. 

Low regulatory scrutiny and the general private nature of BCDs and Private Debt funds (PDs) make an exact accounting of the private credit marketplace difficult to ascertain. However, research in 2025 by the Federal Reserve System into large bank lending records as well as 10-Q SEC filings from BCDs indicates a rapidly growing sector. 

In 2002, the estimated size of the private credit marketplace was roughly $60 billion. By 2024, private credit had grown to $1.4 trillion, with future growth estimates predicting a marketplace of over $3 trillion by 2028.^3,4  

Why Go Private?

The growth in this marketplace is generally traced to two qualities of private credit that distinguish it from traditional depository lending. The first is a willingness to capitalize high-yield investments. Banks and credit unions, with their multi-layered regulatory oversight, cannot generally invest large dollars into distressed and low performing businesses. Depositories face a dual risk in lending to these types of companies. Primarily, the risk comes from the higher likelihood of default that these investments carry, but secondarily, such investments can create uncertainty in the institution’s overall decision-making, leading to bank runs. 

Conversely, funds with a private credit focus are constructed through limited partner investors, who are contractually bound to keep their money with the fund for a prescribed time period — eliminating the possibility of an investment run. Additionally, private credit funds can provide more flexible, bespoke lending terms to borrowers than regulators permit their depository counterparts to offer. 

Displacement… and Higher Risk

If private credit firms are truly expanding credit to distressed businesses in search for a higher yielding return, then this expansion to riskier borrowers would create more leverage in the financial system as a whole, making the system significantly less stable. However, work conducted by researchers at the Federal Reserve Bank of Boston in 2025 suggests that instead of expanding credit, private credit is more likely replacing traditional bank corporate loans. Furthermore, this replacement is actually being fueled in large part from revolving credit lines provided to private credit by their supposed direct competitors: banks.

This type of marketplace movement in financial services is not new, and historically this substitution has precipitated the most disastrous financial collapses the world has ever experienced. 

The Panic of 1907 — perhaps the first truly global financial crisis — featured heavily the connection of banks to the shadow banking world. Following a period of loosening American regulatory standards to increase the money supply and extend credit, a unique locally-chartered financial institution, New York City trust companies, became increasingly tangled within the U.S. credit market. These trusts competed directly with banks for deposits as well as equity investments into growing business sectors.

These trusts were not a major part of the settlement system and therefore carried a low cash-to-deposit ratio when compared to banks. The New York City trusts were also central to the consolidation of financial power in the United States into a few prominent hands. These few financial titans would build networks of trusts, banks and other investment vehicles that would work in coordination to control credit and debt. Trusts, low on cash reserves, would often borrow short-term from banks who were similarly aligned in their financial network. 

This would all come to a head in 1907, when a failed attempt to corner the copper market spooked investors and depositors into moving funds from institutions that had a perceived connection to the failure. Then came the collapse of the prominent Knickerbocker Trust, creating a cascading effect across a web of banks that had supported the trust — who in turn, were deeply intertwined with financial institutions across the country. Soon the crisis spread globally, as it became clear that the dominant financial system responsible for the immense growth of financial institutions in New York City was intimately linked. 

It didn’t matter the individual health of a particular bank, the free run of connected financial institutions in a loose credit environment had created a powder keg that, once lit, tore through the global financial system at an incredible speed. 

Famously, this crisis led to substantial financial reform, including in the creation of the Federal Reserve System — establishing the first true central bank in the United States since the expiration of the Second Bank of the United States’ charter in 1836.

Of course, that was over a century ago. While devastating, the Panic of 1907 unfolded in an environment devoid of many of the regulatory institutions the United States has today. Not only was the American financial system blind to shadow banks like trust companies in 1907, the system barely had any proper tools to adequately monitor depository institutions.

Here We Go Again 

2008 — 100 years later — was a different story. A century of study, legislation, financial crises both large and small, improvements in technology and method, had created a substantially more robust regulatory environment in the United States. However, as the demand for mortgage backed securities rose through the 1990s and 2000s, shadow banks again created a significant weak spot in the economy.

Yes, the demand for more noninterest-based income through the bundling and selling of mortgage CDOs created an environment of increasingly weaker underlying investments. Yes, the mortgage originators, servicers, banks and investment funds moving these products were creating an increasingly tangled web of liability. But it was the insurance market, which was essentially only state regulated, that supplied the gasoline to make the 2008 Global Financial Crisis truly a globally terrifying event. 

Underregulated and lightly supervised, the insurance companies that were supplying the credit default swaps to the world’s investment banks in order to protect the banks’ downside risk had underappreciated the coupled nature of this market risk. As the housing market collapsed, insurance giants like the AIG were unprepared for the correlated failure that came and lacked sufficient capital to meet their losses. Given the size of these insurance companies, and their connection not only to banks but to essentially every financial sector in the United States, their failure represented a complete collapse of the American and global economies.

As with 1907, when the dust settled in 2008, new regulations, standards and oversight institutions — such as the CFPB — were created in order to attempt to effectively scrutinize the systems that led to the crisis. However, just as with 1907, avenues for credit to find underregulated shadow banking remained. 

On the Precipice

Fillat et al. outlined in their research that bank loans to private credit are almost always secured and enjoy the first position amongst fund creditors. Failure of one or a few of these funds, therefore, are unlikely to create systemic damage to the banking system. Additionally, while growing, private credit lending remains a minority within overall corporate borrowing. 

However, the CFPB has been gutted, the current Administration is decidedly pro-deregulation, and private credit exists in an underregulated, shadow sector of the financial services system.⁵ Just as in the deregulated periods that precipitated the crises of 1907 and 2008, the financial services marketplace grows in a state of somewhat uncertainty. And while recent research provides some solace that the private credit marketplace is small and banks are protected from individual failures, economic history demonstrates that growth in the shadows often can metastasize.⁶ Increased demand for high-yielding returns can, and will, spur growth in private credit replacing bank business loans, and correlation within the leverage of these private credit funds would present a systematic risk to the financial system overall. 

A basic axiom of financial regulation remains true: gardens left untended grow weeds and weeds can disrupt and strangle the garden as a whole.

The opinions shared in this article are the author’s own and do not reflect the views of any organization they are affiliated with.

^[1] “Shadow Banking” is generally defined as lending and other financial activities conducted outside of the traditional banking system by less or unregulated institutions or under unregulated conditions.

^[2] This concept was further developed with the merger of the American Research and Development Corporation and J.H. Whitney & Company in 1946 — which was created as an investment vehicle for small businesses established by veterans returning from WWII — and the passage of the Small Business Investment Act of 1958.

^[3] Federal Reserve Board of Governors (2025)

^[4]  Moody’s Ratings (2025)

^[5] Wired Magazine (2025)

^[6]  Fillat et al. (2025)

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