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.

Post-2008 regulations were meant to de-risk banks by pushing risky lending outside the system. However, banks have developed a "frenemy" relationship with private credit funds, both competing and partnering, leading to a massive $1.4 trillion in bank exposure to the sector and reintroducing systemic risk.

Regulatory leverage lending guidelines, which capped bank participation in highly leveraged deals at six times leverage, created a market void. This constraint directly spurred the growth of the private credit industry, which stepped in to provide capital for transactions that banks could no longer underwrite.

The rapid growth of private credit during the zero-interest-rate period parallels the pre-2008 subprime mortgage boom. In both cases, immense capital inflows created pressure to originate assets, leading to rushed due diligence and a degradation of underwriting standards to fill the newly created investment vehicles.

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 massive growth of private capital was a direct consequence of post-2008 regulations like Basel III and Dodd-Frank. By imposing strict capital and liquidity rules on banks, regulators curtailed their risk-taking, creating a vacuum that the private capital industry expanded dramatically to fill.

The rise of private credit has shifted finance away from a bank-centric 'hub and spoke' model. While this disperses risk from typical shocks, it makes the system more fragile in a major crisis because there is no central institution for regulators to easily stabilize and restore confidence.

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.