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In our view, the growth of credit transformation outside the banking system can bring meaningful funding diversification benefits for borrowers—but the plethora of direct and indirect funding and liquidity connections between banks and nonbanks could amplify and propagate systemic risk.

What We're Watching

The headwinds that will shape 2025—including uncertainties around future interest rate cuts, broader financial market volatility, and concerns over the new U.S. administration's tariff and tax policies—could have an outsized impact on smaller and riskier companies.

As S&P Global Ratings assesses emerging and established risks throughout the year ahead, we will continue providing transparency and insight into the structure of public and private markets. Private credit's relative differences to the broadly syndicated loan (BSL) market could exacerbate credit risks, particularly as the space continues to grow—but in some cases private credit's unique structural factors could also serve as mitigants in an uncertain environment.

Private credit exposures have grown rapidly on the balance sheets of nonbank financial institutions (or NBFIs, which include alternative investment funds, asset managers, finance companies, broker-dealers, and structured finance vehicles), as the global financial system has evolved over the last decade. These nonbanks are competing and converging with traditional lenders, offering credit intermediation while also providing funding to each other. While banks remain major players as credit providers to the economy, their growth has been restrained by heightened regulation, regulatory capital requirements, liquidity pressures, and uncertain economic conditions, among other factors. NBFIs have found opportunities to offer new lending solutions to borrowers, often taking on risks or extending credit in structures banks generally avoid.

Overall, U.S. banks' loans to NBFIs, including private credit players, have grown rapidly to now exceed $1 trillion. In asset-based finance, we believe most banks' NBFI exposures to nonbank business, mortgage, and consumer lenders alongside private equity and credit funds are conducted through collateralized warehouses and subscription-line facilities.

What We Think And Why

Although the state of nonbank credit providers is not a source of rating pressure for global traditional banks right now, the potential financial stability risks that the bank-nonbank nexus creates will continue to be an area of attention for 2025.

We believe rated banks have generally well-managed the risk on NBFI loans through conservative structuring, collateral requirements, and diversification. But the fast growth and close connections between traditional lenders and nonbanks could add to systemic risk and future asset quality challenges.

Because banks and nonbank credit providers operate in a nexus and are interdependent for funding and liquidity, NBFI risks could be amplified and spill over into the broader financial system. Nonbanks are exposed to bank-like risks that can take various shapes and materialize during potential market shocks. We believe that broader market confidence could be jeopardized if a nonbank fails, possibly igniting contagion.

Given that large and unexpected funding and liquidity shocks can result in systemwide stress, enabling market participants to have systemic transparency on the entire credit landscape provides a clear line of sight on changing market dynamics and performance.

Some nonbanks have become prominent lenders in segments of the economy (U.S. private credit funds are a key provider of capital for middle market firms and have become increasingly competitive at the lower-end of the speculative-grade corporate sector), while other nonbanks hold large investment portfolios (such as U.K. pension funds in the gilt market). As such, a funding shock on nonbanks could lead to forced sales of assets—which could depress the price of the underlying assets, lead to firesale prices, or severely reduce lending. These actions would result in negative repercussions for banks, considering how traditional lenders tend to be exposed to similar or correlated portfolios and have credit exposure to similar or connected clients.

At first glance, private credit funds appear less exposed to these funding and liquidity risks given their closed-end nature, meaning that equity investments are locked in for the life of the fund that often significantly exceeds seven years. But we see potential innovations that could result in higher redemption risks, such as the possibility for retail investors to invest in private credit funds with shorter redemption opportunities. Private credit funds could also further expand their usage of bank facilities like net asset value (NAV) facilities—which are bank loans secured on the net asset value of the funds—to return cash to their investors. This could expose them to greater rollover risks over time.

The fundamental structural differences between public and private credit create both challenges and opportunities for market participants. Since reporting for private debt investments can be sparse, disclosures in periodic business development companies (BDC) filings and middle-market CLO trustee reports can provide insights on key risk elements like valuations, payment-in-kind (PIK) income, non-accruals, and transactional activity. The ability to maintain documentation quality, the utilization of PIK features to manage cash, and the challenge of valuations in a highly illiquid market will require market participants' clear understanding of the nature of private versus public.

What Could Change

Crises catalyze change—particularly in the field of banking sector regulation. Prudential regulation and rising supervisory standards have substantially strengthened over the last two decades, with each wave of new initiatives forged amid bank failures and attendant economic disruptions.

However, banking regulation is now at a crossroads. Our current base case assumes that bank regulation globally is unlikely to move in lockstep–there could be some targeted easing in the U.S. and Europe but continued tightening in other regions. Over time, it's possible that mounting calls for simplification, a growing sense of regulatory accomplishment, and wider political goals could come into conflict with prudential objectives to reinforce systemic resilience and maintain financial stability.

Given the incomplete information available to the financial markets on many nonbank actors and on banks' exposures to them, stress on large NBFIs could be seen as an indicator of broader issues in the financial sector (including in banks)—and lead to the materialization of funding risks via redemptions or deposit runs.

Unlike traditional banks, nonbanks typically cannot access emergency central bank funding in times of stress. We don't expect governments to use taxpayers' funds to recapitalize any failed nonbanks. This means that nonbanks would need to rely on the provision of liquidity from banks in times of stress or on public authorities' interventions in key or systemic risk markets to mitigate contagion risks, should they arise.

More so than with banks, governments and regulators may be more willing to allow nonbanks to fail during a stress period. Where banks have systems in place to turn to central banks or public authorities for liquidity, nonbanks do not typically have such emergency liquidity sources in place. Facing a liquidity shortfall, they would need to turn to banks or other market sources.

Writer: Molly Mintz