It's Not 2008: Morgan Stanley Counters Why Private Credit Risks Are Not Systemic

By Vishwanath Tirupattur, global head of Quantitative Research at Morgan Stanley

Anxiety around private credit is building. The sell‑off in public BDC equities has continued, alongside a clear pickup in redemptions across private BDCs and semi‑liquid private credit funds. Gates are being tested, and familiar fault lines — software exposure foremost among them — face increasing scrutiny. The market’s unease is understandable: After years of outsized inflows and unusually smooth returns, private credit is now being stress‑tested in real time. While emerging credit risks need to be taken seriously, it is critical to distinguish credit risk from systemic risk. Today’s dynamics look far more like a pricing and sentiment reset than the beginning of a disorderly credit unwind with broad systemic consequences.

The first question in assessing systemic risk is straightforward: has leverage in the system increased? The short answer is no. Historically, a sustained rise in aggregate corporate debt relative to GDP has been a reliable signal of mounting systemic stress. By that metric, the evidence is not compelling. The overall scale of sub‑investment‑grade lending relative to the economy remains contained. Even after accounting for the growth of private credit, total non‑investment‑grade corporate lending as a share of GDP is broadly unchanged from a decade ago. In fact, aggregate corporate debt‑to‑GDP ratios have declined in recent years. (Exhibit 1). These trends suggest that the stock of riskier corporate borrowing has not expanded to levels consistent with broad‑based systemic vulnerability.

What has changed is who intermediates credit. As banks reduced balance‑sheet exposure following post‑GFC regulatory tightening, non‑bank lenders stepped in to finance similar borrower segments. More recently, growth in private credit has come largely at the expense of bank lending and public credit markets, where issuance was choppy amid the inflation shock, rapid rate hikes, and sustained outflows in 2022–23. At the same time, growth in high‑yield bonds and leveraged loans has been notably tepid. This substitution matters: the rise of private credit reflects a structural shift in credit intermediation, not a surge in aggregate leverage.

A related concern is whether stresses in private credit can meaningfully transmit back into the banking system. Again, the comparison with prior credit cycles is instructive. Private credit is non‑bank lending, by definition, and the dominant vehicles — BDCs and private credit funds — operate with explicit constraints on leverage. Most BDCs have a debt-to-equity ratio at or below 2x. Leverage in private credit funds is typically modest and tightly managed. Banks do provide financing to private credit lenders, but this is back‑leverage, not direct credit exposure — structured with substantial protections, including conservative advance rates, senior positioning, and strong collateral and covenant packages. This stands in sharp contrast to the pre‑GFC period, when banks’ own leverage was a multiple of today’s level and warehoused highly leveraged credit risk directly on balance sheet. Today, bank exposure to private credit is indirect, senior, and well‑buffered—materially reducing the scope for private‑credit stress to metastasize into a broader banking or systemic event.

Another source of systemic concern is the risk of forced asset sales — and the recent activation of redemption gates at some private credit managers has clearly added to investor agita. But gating is not a sign of structural failure; it is the structure working as designed — a feature, not a bug. These vehicles were built to prevent fire sales of inherently illiquid loans during periods of stress. As redemption requests have risen, gates are being tested — and in some cases pulled — not because portfolios are unraveling, but because managers are choosing to protect remaining investors rather than liquidate assets at unfavorable prices. That trade‑off matters: gating limits stress within the vehicle and spreads it over time, sharply reducing the risk of disorderly price cascades or spillovers into broader credit markets.

The same logic applies elsewhere in the private credit ecosystem. Private credit CLOs have structural mechanisms that redirect cash flows within the liability stack during periods of stress, limiting the need for asset sales. Insurance companies may face policyholder withdrawals, but are insulated by surrender penalties, liquidity facilities, and allocations to more liquid assets, well before they would be forced to sell illiquid Level 3 exposures. Together, these design features argue against forced selling as a meaningful source of systemic risk.

To be clear, we are not private credit Pollyannas. The credit risks are real and material, and we have highlighted them in our research (see here, and here). Private credit borrowers tend to be smaller, with leverage and coverage metrics that closer to the weaker end of the credit spectrum relative to public markets. Private credit is also meaningfully exposed to software, where disruption risk from AI is non‑trivial and as we have discussed at length (see Mapping Software Exposure in Leveraged Credit).

But acknowledging credit risk is not the same as signaling systemic risk. Our view is that while the asset class is facing a genuine credit cycle — one that will produce winners and losers — the evidence does not indicate that these stresses are building into a broader, system‑wide threat. Credit risks in private credit are significant; systemic risk concerns, in our view, are overstated.

More in the full Sunday Start note from Morgan Stanley, available to pro subs.