Everyone's worried about private credit blowing up. Should they be?

As partnerships between banks and asset managers grow, so have concerns that these developments could “blur the lines between traditional and alternative lending” and create new channels for systemic risk.(1)

These observations reflect understandable caution, but they risk oversimplifying the nature of modern co-lending frameworks and mischaracterising their governance mechanisms. By revisiting how co-lending operates, examining the incentives of each party and assessing where risk is genuinely transferred or retained, we believe fears of widespread systemic spillover are overstated.

Far from eroding the boundaries of regulated credit markets, co-lending to the extent that it is pari passu and senior secured/first lien, can anchor private credit to the prudent framework that has governed European bank lending since the Global Financial Crisis (GFC).

PIK-ing apart defaults

The private credit and banking industries operate with fundamentally different definitions of default, which materially influences how market dynamics are interpreted. There are ‘good PIKs’ and ‘bad PIKs’. For example, if you underwrite a loan that pays from inception 6% cash interest and 2% PIK interest to accommodate the profile of company’s cash flows, this is a ‘good PIK’. 

On the other side, if during the life of the loan you convert all the cash interest into PIK interest because the company does not have the money to pay interests, this is a ‘bad PIK’. Under European banking rules, converting cash interest into PIK interest constitutes a default event. Many private-credit portfolios, however, do not treat a ‘bad PIK’ as a default, revealing a significant divergence in how regulated banks and unregulated asset managers recognise and manage credit deterioration.

For banks, regulatory capital charges increase with underlying risk: the riskier the exposure, the more capital must be held. Because regulated institutions must protect depositors, riskier assets – such as unitranche loans at 6x EBTDA leverage – become economically unattractive. Banks therefore tend to avoid unitranche/high levered structures because they dilute value and inflate capital requirements.

This difference in risk recognition also affects how defaults are measured. While Figure 1 shows a default rate of 1.8%, applying a banking-standard definition of default (including PIK conversions) raises the comparable figure to nearly 6%.

Figure 1: Current private credit default rates

One reason some private credit portfolios report lower default rates is the widespread use of PIK interest amendments, which can account for up to 20%-25% of the invested portfolio. By converting cash interest into PIK interest in a bullet loan, borrowers effectively pause cash interest payments, delaying the point at which financial stress is formally recognised. In practice, PIK interest structures can obscure true credit deterioration and make default rates appear lower than they would under stricter banking standards.

Discipline from crisis

The GFC accelerated regulatory reform, prompting banks to systematically de-risk their portfolios through disciplined underwriting practices.(2) 

At the counterparty level, highly levered businesses are generally avoided. For smaller companies, banks employ an actuarial approach, constructing diversified and granular portfolios to minimise concentration risk.

Banks also manage balance-sheet structure carefully: mezzanine tranches are often sold to credit funds while senior exposure is retained, a process sometimes mistakenly conflated with co-lending in pari passu first lien/senior secured loans. In addition, Significant Risk Transfers (SRTs) are used to offload first-loss risk and further reduce the risk exposure synthetically.

Alignment with bank discipline

Parallel lending is designed to align senior secured/first lien and low levered loans while providing efficient access to mid- and upper-mid-market corporate borrowers. An asset manager invests alongside banks that retain meaningful exposure, focusing on loans where regulatory capital charges remain manageable relative to the bank’s cost of capital. The focus of the bank is to maintain the relationship with their good clients, while optimising tier 1 profitability. 

Investments are made pari passu in first-lien, senior-secured loans, with the asset manager acting as lender of record, avoiding sub-participations or secondary trades. Parallel lending corresponds to the Originate-and-Share bank business model (where the bank remains co-invested) and it is different from the Originate-to-Distribute bank business model, (where the bank downloads 100% of risk to a third party).

A convergence of underwriting standards

Concerns around potential contagion between direct lending and the banking system often stem from a circular dynamic: banks may avoid holding high-risk assets yet provide leverage to private credit funds that invest in those same exposures. In such cases, banks could inadvertently re-absorb the risks they sought to avoid.

A parallel lending model is designed specifically to avoid this outcome. Rather than seeking leverage to invest in assets banks would not hold, the framework aligns with exposures that remain attractive to banks under Basel capital rules. Co-originated or co-invested loans are senior-secured, low-leverage and governed by rigorous loan-facility standards. This eliminates structural arbitrage and maintains alignment with the discipline underpinning traditional banking practices.

Parallel lending also acknowledges that asset managers offering periodic liquidity windows must apply prudence like banks: diversified, granular portfolios with low leverage to safeguard investor capital. Parallel lending also emphasises the importance of amortising loans and 100% cash interests to improve the liquidity profile and function similar to deposit-like liabilities.

Cooperation not contagion

We believe the increase in cooperation between banks and private lenders within the Originate-and-Share/parallel lending model does not signal a breakdown in underwriting discipline or regulatory oversight. Nor does it mirror the uncontrolled interdependence that characterised previous periods of financial instability. 

Co-lending partnerships – particularly those grounded in regulated bank underwriting standards and because they are pari passu and senior secured/first liens - can mitigate rather than amplify systemic risk.

It is important to distinguish between models that genuinely create opacity or leverage-driven contagion and those, such as regulated parallel-lending arrangements, that operate within bank-standard underwriting, capital rules and international accounting frameworks. Lumping all forms of cooperation into a single narrative of rising systemic danger obscures these critical distinctions.

The co-lending landscape is not monolithic: some models may warrant scrutiny, but others offer a stabilising complement to traditional bank lending, expanding credit availability without weakening regulatory safeguards. Alignment with bank-standard credit practice remains one of the most effective ways to manage risk and prevent the build-up of hidden fragilities.

On top of the alignment, asset managers should learn from the lessons of the GFC. Asset managers can and should adopt more stringent due diligence requirements and advanced agentic AI credit experts to improve risk-return profiles. For example, an asset manager may reject around 85% of a bank’s proposals of co-investment to target an investment grade equivalent risk profile in a parallel lending portfolio.