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Credit performance has so far exhibited resilience amid the global market volatility spurred by the intensifying global trade conflicts, which are likely to weaken conditions across the credit landscape.

But the prevailing certainty of uncertainty may pose particular pressures for the smaller and riskier companies that have fueled demand for private credit—especially against the backdrop of increased interconnection between banks and nonbank financial institutions (NBFIs).

The growth in size and complexity of the global financial system over the last decade is exemplified by the increasingly important role alternative investment funds, asset managers, and other NBFIs in intermediating credit and taking on bank-like risks. Now, the plethora of direct and indirect funding and liquidity connections between banks and nonbanks could amplify and propagate systemic risk.

The state of nonbank credit providers is not a source of rating pressure for global traditional banks presently. But while relatively benign funding conditions have limited financial stability risks so far, the macro-financial shocks triggered by trade tariffs could bring on renewed turbulence. S&P Global Ratings will be closely monitoring potential financial stability risks throughout 2025.

Market participants' need for systemic transparency on changing dynamics and performance will increase as volatility disrupts capital markets. In this edition of Private Markets Monthly, our subject matter experts explore key contagion and stability risks for nonbank credit providers across the credit spectrum.

What Role Do Nonbank Credit Providers Play In The Overall Global Financial System?

Nicolas Charnay, managing director & sector lead for financial institutions:  As the global financial system continues rebalancing, nonbank actors are expanding faster than banks in almost all regional markets. These nonbank credit providers are a meaningful alternative funding source to traditional lenders across geographies—managing $70.2 trillion in assets worldwide and representing about 10% of total financial assets and nearly 30% of total NBFI assets.

Investment funds tend to dominate nonbank credit providers, especially in advanced economies. Comparatively, finance companies (or fincos) and broker-dealers are more popular in emerging markets across Asia-Pacific and Latin America.

Brendan Browne, managing director for financial institutions:  Banks remain major players as credit providers to the economy, but 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 and/or extending credit, terms, and execution in structures and solutions that banks generally avoid.

At the same time, banks and nonbanks are competing and converging in the financial system—both offering credit intermediation and with banks also providing funding to nonbanks. In the U.S., Federal Deposit Insurance Corp. (FDIC)-insured banks reported $1 trillion of loans to nonbanks at the end of last year, with another roughly $770 billion in unfunded commitments. This shows that banks are increasing their interlinkages with nonbanks despite also facing increasing competition from them.

Banks' loans to NBFIs have surged alongside the growth of private markets. Since the global financial crisis, a proliferation of business development companies (BDCs), private equity and credit funds, fintech players, and insurance companies (who borrow from banks and partner with asset managers) have targeted credit assets.

In an indication of the interplay and interconnection between public and private markets, banks are largely lending to NBFIs like private equity and credit funds through collateralized warehouse financing and subscription line facilities. This private credit growth remains heavily concentrated in the U.S., where new year-end 2024 disclosures suggest that subscription-line facilities may equate to almost a quarter of banks' NBFI exposures.

Denis Rudnev, director for leveraged finance & private credit:  Private credit demonstrated its resilience last year during the first true test of its durability and competitiveness in relatively normalized credit markets. In many ways, private and public markets performed similarly in 2024, with spreads tightening due to a surge in refinancings and opportunistic transactions as loan demand outstripped supply. Both sides of the credit spectrum appear to have transitioned to a higher cost of funding without experiencing substantive default rates thus far.

But there are fundamental structural differences between public and private credit, and those differences create both challenges and opportunities for private credit market participants. The ability to maintain documentation quality, the utilization of payment-in-kind (PIK) features to manage cash, and the challenge of valuations in a highly illiquid market will require participants' clear understanding of the nature of private versus public.

Nicolas Charnay:  Traditional banks are also net recipients of funding from NBFIs. Although direct exposures may appear limited at a global level (representing 1.9% of total bank assets), they are more significant in certain jurisdictions after a recent period of growth (particularly in the U.S.). We believe that transparency on individual firms' exposures remains relatively low. Considering the core lesson from the global financial crisis that fast growth and financial innovation can create systemic risks, financial regulators may require more transparency on banks' exposure to private credit.

Where Are The Most Prominent Contagion Risks?

Brendan Browne: 

We believe the growth of credit transformation outside the banking system can bring meaningful funding diversification benefits for borrowers. In our view, major global banks have improved their counterparty credit risk management and generally well-managed the risk on NBFI loans through conservative structuring, collateral requirements, and diversification. Based on current levels, we do not see a high risk that loans to NBFIs will result in material asset quality issues for rated banks.

But while banks limit the risk on NBFI lending with collateral and structuring, losses can occur—and as such we view the rapid growth of banks' NBFI lending as an indicator of risk. NBFIs' exposure to funding and liquidity risks enhances their vulnerabilities to market shocks, which could be amplified and spill over into the broader financial system—intensifying and propagating systemic risks, particularly if potential problems that arise at NBFIs ricochet back on their bank lenders.

Nicolas Charnay:  Market shocks tend to create a redistribution of liquidity flows across actors, testing the resistance of their funding model and liquidity buffers. Banks are particularly exposed to funding and liquidity risks, relying on short-term funds (like deposits) to finance long-term assets (such as loans). In many ways, nonbanks are also exposed to similar funding and liquidity risks through redemption, rollover, and margin risks.

Considering how banks and nonbanks share exposures to end clients or similar portfolios, a sudden and massive deleveraging or forced selling by redemption-vulnerable nonbanks could spread losses throughout the banking system or create a liquidity crunch for certain borrowers that hurts the real economy.

Overall, large and unexpected funding and liquidity shocks can result in systemwide stress. Some nonbanks have become prominent lenders in segments of the economy (like U.S. private credit funds in 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 sale of assets, which could depress the price of the underlying assets (or even lead to firesale prices), or to severe cut-back in lending. These actions would have negative repercussions for banks in particular.

In the past five years, we have seen three major stress episodes: the "dash-for-cash" at the start of the COVID-19 pandemic in 2020; the liquidity stress faced by U.K. pension funds following liability-driven investment strategies in September 2022; and the banking turmoil of spring 2023 spurred by the Silicon Valley Bank failure. In the first two situations, the interdependencies between traditional lenders and NBFIs were a key factor in amplifying and propagating stress, with leveraged nonbanks selling assets to face funding pressures stemming from margin calls or redemptions.

It is still early to tell, but the tariffs announced on April 2 have spurred a global sell-off in equity and Treasury markets—which, depending on the length and extent, could turn into a liquidity shock for the financial system.

Denis Rudnev:  Because of private credit's fundamental nature as the primary source of funding for small to medium enterprises (SMEs) and private markets' overall capacity to carry riskier credits, smaller and riskier entities are likely to remain comparatively vulnerable to unanticipated stresses that may result from the headwinds that will shape 2025. These headwinds include uncertainties around the U.S. administration's trade policy, future interest-rate cuts, and broader financial market volatility.

The unique structural factors of private credit could elevate risks or potentially act as mitigants.

Brendan Browne:  At first glance, private credit funds appear less exposed to funding and liquidity risks given their closed-end nature, meaning that equity investments from investors are locked in for the life of the funds, which often exceed seven years. But we see potential innovations, including the possibility for retail investors to invest in private funds and a growing recourse to bank facilities, that could result in higher risks of either end investors withdrawing their funds from investment funds or firms not managing or refinancing their activities in the wholesale markets.

For instance, the subscription and net asset value (NAV) facilities banks have extended to funds could be tested in a period that brings declining asset valuations and elevated credit losses on fund investments. We believe that increased use of these facilities has added to the funds' leverage, perhaps weakening the resiliency of some. Meanwhile, counterparty risks can be material in warehouse lending where counterparties can be small, lack diversification, or participate in risky lending areas.

Additionally, the potential for idiosyncratic and unexpected events or company-specific challenges that bank lenders may lack protections for also pose risk—leading to sharper-than-expected declines in collateral values that lead to losses.

Denis Rudnev: Our substantial credit estimate universe serves as a window for understanding private credit's performance—and its structural differentiators from public markets—while providing a unique view of credit quality for unrated entities whose loans are held in middle-market collateralized loan obligations (CLOs).

Credit estimate payment defaults have remained low, but that trend will be tested as new risks emerge. In some cases, sponsors may choose to walk away if the economics no longer justify further support from a valuation standpoint and borrowers are extensively stressed.

Carmi Margalit, managing director & sector lead for insurance:  In our view, insurance would only experience systemic risk if there were a monumental, widespread event or shift of credit quality within private credit. Any potential issue with private credit defaults would not meaningfully affect the insurance sector, as these participants typically invest in investment-grade structures within this alternative asset class.

We do not see any substantive systemic risks to insurance at this time. In a downside scenario, which we view as highly unlikely, insurers could potentially experience risk if individual insurance companies become overly concentrated in private credit. Insurers could also experience risk if the industry faces challenges raising capital and investors become more hesitant due to private credit's situational transparency amid market volatility.

How Can Geopolitical Shocks Affect Financial Stability Across The Bank-Nonbank Nexus?

Nicolas Charnay: 

Systemwide funding stress episodes can largely be explained by the vulnerabilities created by the bank-nonbank nexus, but they typically materialize only when funding conditions tighten. In our view, geopolitical risks and trade policy uncertainties pose the biggest risk to global credit conditions. Geopolitical risks could translate in macro-financial shocks to confidence, via volatility in commodity prices and through physical and cyber-attacks. These events would affect both the financial markets and the real economy and generate financial risks to banks and nonbanks.

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.

Brendan Browne:  An economic downturn could place pressure on the asset quality of nonbank exposures with their potential weak performance affecting banks. Banks could also be put in a difficult position of having to restructure nonbank loans or take possession of, and liquidate, collateral. In our view, that will make it crucial for banks to carefully structure, diversify, and monitor nonbank exposures—particularly if they continue to grow quickly in this area.

Writer: Molly Mintz