Private credit: Is the Goldilocks period over for credit?

We expect developments in the private credit market to remain in the headlines and contribute to the imminent repricing of higher-beta credit markets. We coined this Baby Bear as one of the key risks to the Goldilocks credit story for 2026. We don’t view this as a systemic risk event. Banking system exposure, both direct and indirect, appears manageable and recent analysis from the Office of Financial Research and Moody’s provides reassurance.

However, important questions remain about the broader consequences for spread markets, default rates, and the impact of questionable rating practices. There are growing concerns that ratings shopping and limited oversight have fuelled ratings inflation aimed at securing investment-grade status for insurance sector allocations. The likes of BIS are already investigating some ratings, and the ECB is set to start a new round of checks on banks’ private credit holdings. Whilst there is certainly unease rising, we do not expect a full implosion.

The system is not collapsing, but it is re-pricing risk.

Given the recent news flow, continued redemption pressure across private credit funds seems unavoidable, and most funds are likely to maintain caps or gates on withdrawals. A high level of redemptions matters. It creates a situation where funds facing sustained outflows must reserve liquidity to meet withdrawals. As such, they may be forced to sell assets rather than originate new loans. This slows distribution cycles, reducing the sector’s ability to underwrite new deals.

Market commentary is broadly aligned in suggesting that the credit cycle appears close to turning. As the Goldman Sachs CEO remarked only last week, the credit cycle “has not been repealed”, identifying AI disruption as a potential catalyst. However, the deeper concern lies in the multiple potential channels of contagion should pressure intensify or additional negative catalysts emerge. Private credit remains a lightly regulated market with uneven practices, risk concentration and liquidity mismatches.

AI disruption and geopolitical stress could be the triggers.

AI disruption and geopolitical stress, particularly the conflict in the Middle East, represent structural, long-term headwinds. AI highlights the risks associated with the sector’s pronounced concentration on software and SaaS lending. If AI-driven disruption pushed default rates to twice Fitch's current 5.2% private credit default rate, the implications for the cost of capital would be significant. Meanwhile, the geopolitical backdrop reinforces the likelihood that financing costs will remain elevated.

While direct exposures to private credit may not constitute an immediate systemic threat, indirect transmission channels are far more concerning. As the credit cycle turns, financing costs, already influenced by the expansion of private credit structures, are set to rise further. At the same time, the Middle East conflict, stubborn inflation, and a rising likelihood of renewed rate hikes create a backdrop of mounting macro‑financial stress.

In any plausible scenario, even one less adverse than the central case, redemption pressure across private credit vehicles is likely to continue, slowing the pace of new financing. Credit spreads and underlying rates have already risen meaningfully. In short order, they've pushed funding costs upward by as much as 400bp for high-beta borrowers.

This raises a critical policy question: what scope remains for central banks to respond if funding markets deteriorate further? Restarting large-scale asset purchase programmes to compress borrowing costs would prove extremely difficult, if not impossible, while inflation remains above target.

The coming period, therefore, represents a significant test for the private credit market, as both internal vulnerabilities and external shocks converge. For the broader credit market, this shift is set to intensify pressure as the credit cycle turns. Credit spreads and financing costs may be only in the early stages of a longer‑term move higher.

Double whammy for credit as rates and spreads could be heading up.

All in all, dark clouds are gathering. In ING Credit Strategy, we like to frame market dynamics through fairytales. In that spirit, Baby Bear returns – with the ECB’s CSPP backstop close behind.

In practical terms, stress in private credit (Baby Bear) could trigger a broader repricing across leveraged loans, high yield and ultimately investment‑grade credit as contagion spreads. Financing via both private and public markets would become materially more expensive – and for some borrowers, effectively unavailable.

In the meantime, inflation fears stemming from the Middle East turmoil have central banks considering higher rates. In the current environment for private and public credit markets, it’s difficult for rates to rise. This leads central banks to delay rate hikes (or even cut rates) and, subsequently, restart quantitative easing (CSPP, amongst others).

Issuers and US regional banks are most exposed.

Insurers come to mind first as being exposed to private credit. An expected 10-25% of assets are allocated to private credit by US insurers, 10-15% by European insurers (though this is more of an ALM optimisation tool), and 12-20% by UK insurers. However, when the focus shifts to leveraged private credit, the allocation percentage declines. Given questions about the ratings' validity and possible rating inflation, these exposure levels raise concerns.

US regional banks carry meaningful exposure to private credit, with roughly 4–5% of their assets tied to direct private credit holdings. Also, US regional banks are on the hook for liquidity mismatches, meaning many private credit firms/funds/BDCs will draw on liquidity lines, thereby weakening capital. Balance sheets will expand at the worst time. Higher funding needs will reduce liquidity buffers. Hence, underlying assets deteriorate, and the collateral posted decreases.

For European banks, exposure to the non‑bank sector could impact them through weaker credit quality, higher impairments, and lower earnings. In a severe scenario, this could erode capital and raise funding costs as market risk premia increase. For banks, however, the spillover shouldn't be too drastic, since much of their exposure is secured through asset-backed securities. Yet the risk of wider repricing of credit remains, and of course, a feeling of unsettlement can rise as the ECB begins checks.