Shadow Banking Surges: Why Traditional Lenders Are Fueling A Private Credit Boom

The American financial system is undergoing a quiet transformation. Lending to non-bank financial groups, including buyout firms and private credit funds, has surged by 20 percent over the past year, reaching $1.2 trillion. This expansion is driven not by these firms alone, but by the banks themselves. Traditional lenders, long regulated by strict capital requirements and oversight, are now playing a central role in fueling the rise of shadow banking. The question is no longer whether private credit is growing, but why regulated institutions are funding that growth—and what risks this might carry.

The Appeal of Non-Bank Financial Groups

Private equity firms and credit funds are increasingly prominent borrowers in the market. They operate with fewer disclosure obligations than public companies, structure deals with more flexibility, and move faster than traditional corporate borrowers. In recent years, these groups have become major players in leveraged buyouts, opportunistic financing, and distressed asset plays.

Banks, meanwhile, have been eager to deploy capital. With interest rates no longer at zero but bank lending standards still tight for many corporate clients, the structured credit offered by private firms presents an attractive opportunity. These deals often generate higher yields, and the banks can participate without taking direct exposure to riskier assets.

How the Lending Works

This credit boom is not happening through traditional corporate loans. Instead, banks are lending to private funds via tailored facilities. Common structures include warehouse lines, subscription credit lines backed by limited partner capital commitments, and net asset value (NAV) loans, where a fund borrows against the estimated value of its portfolio.

In many cases, banks are not the end lenders but are providing the infrastructure. They offer credit facilities to private credit funds who then lend to mid-sized businesses, real estate ventures, or LBO targets. In others, they act as syndicators or agents, helping assemble club deals that allow multiple lenders to share risk.

These arrangements are complex and bespoke, often sitting outside the spotlight of public capital markets. But they are large, rapidly growing, and tied in multiple ways to the health of underlying borrowers—many of whom are already highly leveraged.

Why Banks Are Eager to Lend

Several factors drive banks' involvement. First, there is regulatory arbitrage. Loans to non-bank entities are subject to different capital treatment than loans to individuals or corporates. By lending to a private credit fund rather than directly to a company, a bank can reduce the amount of capital it must set aside, even though the economic exposure is similar.

Second, banks are earning significant fees. These deals are often accompanied by advisory mandates, hedging arrangements, and ancillary business such as custody or fund services. Lending to a private equity client can generate a long-term relationship across multiple business lines.

Third, the risk appears manageable—on paper. By securing loans against fund commitments or diversified portfolios, banks believe they are insulated from individual asset failures. This perception, however, depends heavily on asset valuations and the continued inflow of capital to private markets.

The Risks Beneath the Surface

Despite the appearance of control, the risks are building. Private credit funds operate with far less transparency than banks or public debt markets. Their internal risk models are not subject to regulatory review, and their assets are frequently illiquid or hard to value.

If these funds come under stress—whether due to defaults, poor performance, or a liquidity crunch—their ability to repay bank loans could be compromised. Worse, if the assets used as collateral decline in value, the banks could face unexpected write-downs.

There is also concentration risk. Many private credit deals are exposed to similar sectors: real estate, technology, leveraged buyouts, and distressed assets. A downturn in any of these markets could cause simultaneous stress across dozens of funds and hundreds of loan agreements.

A New Competitor to Public Markets

Private credit’s rise is also shifting the financial architecture of the US economy. Once, large companies issued bonds or took syndicated bank loans. Now, more and more are turning to private debt providers who offer faster execution, fewer covenants, and discretion. These deals remain off-market, meaning investors and regulators have less insight into the true leverage and fragility of the corporate sector.

In many cases, the underlying borrowers are firms that would struggle to raise capital on public markets. The private credit model, backed indirectly by banks, is enabling riskier companies to take on more debt than they otherwise could.

At the same time, a liquidity mismatch is emerging. Private credit funds hold long-term, illiquid loans but rely on short-term credit lines from banks. In times of stress, this dynamic can lead to sudden and severe liquidity issues—a pattern familiar from previous financial crises.

Oversight Gaps

The private credit boom has outpaced the regulatory structure designed to monitor it. No single agency has full visibility into the ecosystem. The Federal Reserve, the Office of the Comptroller of the Currency (OCC), and the Securities and Exchange Commission (SEC) each have partial oversight, but none can assess the full picture of interlinkages between banks and private funds.

Global financial bodies, such as the Financial Stability Board (FSB) and Bank for International Settlements (BIS), have raised concerns. They warn that systemic risks may be shifting outside the regulated perimeter, with potentially destabilizing consequences if funding dries up or asset values fall.

US regulators have begun discussing enhanced reporting requirements for non-bank lenders and greater scrutiny of banks’ exposure to them, but no comprehensive framework has yet been put in place.

Conclusion

The rise of lending to non-bank financial groups reflects a new phase in the evolution of credit markets. Banks are not stepping back—they are deeply involved, even if their role is no longer front and center. By funding private credit growth, they are profiting from high-yield opportunities and sidestepping some regulatory burdens. But they are also embedding themselves into a system whose opacity and fragility could magnify shocks.

As the $1.2 trillion in exposure grows, so too does the need for transparency, oversight, and a clear understanding of who bears the ultimate risk. The shadow banking system may operate in the background, but its failure would be felt across the entire financial landscape.

Author: Brett Hurll