Large banks have offloaded riskier loans to private credit, which is now more accessible to retail investors. According to Crossmark's Victoria Fernandez, this concentration of risk in a less transparent market, where "cockroaches" may be hiding, is a primary systemic concern.

Private credit grew by taking on riskier loans that banks shed after Dodd-Frank, making the core banking system safer. However, banks now provide wholesale leverage to these private credit funds with minimal due diligence, creating a new, less transparent concentration of risk.

While private credit faces headwinds that may lead to sluggish growth and poor returns, it is unlikely to trigger a systemic crisis. This is because linkages to the traditional banking system involve significantly less leverage in this cycle compared to the period before the 2008 Global Financial Crisis, limiting contagion risk.

Unlike the concentrated banking risk of 2008, today's risk is more diffuse. The danger isn't a sudden collapse, but rather a slow degradation of returns as immense pools of private capital compete for a limited number of productive lending opportunities.

Contrary to popular fears, private credit has structural advantages over banks. With retail investors comprising only ~20% of funds (which have redemption gates), the asset-liability mismatch is far lower than in the banking system, which relies on demand deposits to fund long-term loans.

Due to the private credit market's opaqueness, complexity, and hidden interconnectedness, any significant credit event would likely trigger a 'sudden stop' liquidity event. This poses a greater systemic risk than a slow, corrosive problem, as it could catch regulators completely off guard.

While most US economic cycles appear healthy, the opaque private credit market represents the most significant systemic risk. Recent signs of stress, such as fund redemption limits and high exposure to volatile sectors like software, are reminiscent of the "contained" problems that preceded the 2008 financial crisis.

Banks can use more leverage and hold less capital by lending to a private credit fund than by making the same risky loans directly to a business. Former FDIC Chair Sheila Bair states this regulatory arbitrage in risk-based capital rules is the primary driver of the private credit boom.

The Basel III regulations, intended to de-risk the financial system by making risky lending expensive for banks, had an unintended consequence. The demand for risky loans didn't vanish; it simply migrated from the regulated banking sector to the opaque, unregulated private credit market, creating a new systemic risk.