Asked to name the biggest short-term risk facing European banks, investors gathered in London put private credit at the top of the list by a wide margin. Asked the same question from the stage, the chief executives of those banks said the problem sat outside their perimeter: a natural correction among isolated participants, nothing systemic. Both answers are defensible. Only one of them is currently being stress-tested by the Bank of England, and the results will not arrive until 2027.
By Scott Townsley · Investment Director · 9 min read
The Bottom Line, Up Front
- Market: 41% of respondents to a poll at Morgan Stanley’s European Financials Conference named private credit the top short-term risk for European banks, well ahead of disappointing loan growth at 23% and falling rates at 16%. UK banks are estimated to hold £173bn of banking book exposure to private market funds and to highly leveraged sponsor-backed corporates, equivalent to 8% of their total wholesale committed limits.
- Shift: supervisors have stopped debating whether to look. The Bank of England sent 46 firms a severe global recession scenario in June, the ECB began on-site inspections of bank private credit exposures in March, and Fitch’s US private credit default rate reached a record 6% in the second quarter.
- For you: when every institution is watching the same risk, the effect on borrowers is rarely a dramatic credit crunch. It is slower processes, harder questions, and a widening gap between businesses that can answer them convincingly and businesses that cannot.
Term to Know: System-Wide Exploratory Scenario
A conventional bank stress test asks one institution whether it survives a shock. A system-wide exploratory scenario, or SWES, asks a much harder question: what happens when everybody reacts at once. The Bank of England’s second SWES, launched in December 2025 and now in its scenario phase, covers 46 firms including banks, insurers, pension funds and alternative asset managers, and runs in two rounds precisely so participants can respond to each other’s likely behaviour. The Bank cannot compel participation from firms it does not regulate, so this is a voluntary exercise. Interim findings are due later this year, with the final report in 2027.
The poll and the panel
More than 650 investors from 120 firms attended Morgan Stanley’s European Financials Conference in London. The poll taken in the room was unambiguous: private credit was the single largest perceived short-term risk to European banks, at 41%, with disappointing loan growth a distant second on 23%, rates falling below 2% on 16%, disappointment with capital returns on 13%, and AI disruption trailing on 7%.
The executives on stage offered a calmer reading. Credit markets, they argued, have behaved consistently for more than a decade, and what the market is now witnessing is a natural correction rather than a structural failure. The problems that had generated headlines were attributed to isolated participants with less experience in the business. Some chief financial officers went further and suggested provisions might be lower this year, not higher. Morgan Stanley’s own analyst covering European banks summarised the mood with a carefully hedged observation: executives acknowledge the risks facing private credit funds, but the path from those risks to actual bank losses is not obvious, and that is reassuring for now.
Those last two words are carrying an enormous amount of weight, and everybody in the room knew it.
What that explanation does and does not tell you
It is worth being precise about what was actually claimed. An attribution made in a conference room, mid-cycle, is not a finding; it is a characterisation, and it is unfalsifiable until the cycle finishes making its case.
The structural point underneath it is nonetheless real. The asset class was built to lend where bank capital rules made bank lending uneconomic, which means its natural home is in the sub-investment-grade space, against borrowers whose credit quality and risk weighting does not align to bank regulations or regulatory capital requirements. Elevated default rates relative to a bank loan book may well therefore be an expected property of the model rather than evidence of its failure, and investors are compensated for precisely that risk through spread. Comparing the two default rates directly, as a good deal of commentary now does, carries inherent problems.
That explains the risk profile of the asset class. It does not defend any individual loan, and it does not discharge the question of what a sustained rise in defaults does to the funds that hold them, or to the institutions financing those funds.
There is a timing dimension the panel did not address. More than half of the default events Fitch recorded in the second quarter were maturity extensions, which points back to loans originated in 2021 to 2023, when capital was flowing into the asset class faster than it could readily be deployed. Periods of heavy inflow tend to shift terms towards borrowers, and that can be a contributing factor in how a vintage performs later. What can influence performance is where in the cycle a loan was originated, and that vintage is now arriving at maturity.
European banks are, for the most part, not exposed to private credit through the underlying loans. They are exposed through lending to the funds, and that lending is overwhelmingly senior, secured and structurally conservative. Subscription lines, the most common form of bank financing to private credit funds, are secured against undrawn commitments from limited partners whose own credit quality sits comfortably in investment grade territory. Fund-level facilities are typically advanced at conservative loan-to-value ratios against diversified portfolios. The £173bn headline figure the Bank of England produced from its information-gathering exercise deserves the same treatment: it sounds enormous, but it represents around 8% of UK banks’ total committed limits across their wholesale portfolios, much of it undrawn, spread across counterparties that are among the better-capitalised institutions in the market. European bank capital and liquidity positions are in a different universe from 2007, and the idea that a wave of mid-market corporate defaults inside credit funds translates mechanically into a European banking crisis does not seem likely on the current numbers.
What This Means for You
The practical translation of an entire industry watching the same risk is credit committee friction. Expect longer approval timelines than you experienced in 2024, sharper questions about EBITDA add-backs and cash conversion, and sector-level scrutiny that has nothing to do with your individual performance. None of this is a refusal, but all of it costs time. If you have a refinancing or acquisition facility landing in the next twelve months, build a longer runway into your planning than you think you need, and start the conversation earlier than feels necessary.
What is worth keeping an eye on
Saying the problem sits outside your perimeter describes where you have drawn a line; it does not assess the risk on the other side of it.
Three things about the reassurance do not sit comfortably.
The first is the confidence itself. Every credit problem looks idiosyncratic on the way in and tends to look correlated on the way out. The credit failures that unsettled this market last year were also described at the time as isolated and sector-specific. Some of that was true. It was also the most comfortable explanation available.
The second is that the debate is preoccupied with losses when the more likely consequence is withdrawal. If credit funds turn cautious at the same moment, for their own portfolio reasons rather than because of any single borrower, the effect lands on borrowers rather than on balance sheets. Deals do not complete. Refinancings stall. Capital expenditure gets deferred. No bank needs to take a single loss for that to happen, and for a mid-market business it is the outcome that actually matters.
The third is that the panel’s perceived comfort has little to measure itself against. The Bank of England is running a three-year exercise across 46 firms because nobody, the banks included, can currently map these exposures with confidence; the Bank has been explicit that it is looking at data gaps, valuation, leverage and reliance on rating agencies. Until that work reports, saying you are relaxed about private credit describes a position rather than a conclusion. You cannot be reassured about something nobody has yet measured.
Same Market, Five Very Different Assessments
| Who | Position | Basis |
|---|---|---|
| Investors, Morgan Stanley conference | Private credit is the top short-term risk to European banks, at 41% | Conference poll, March 2026 |
| European bank CEOs and CFOs | No systemic risk; stress attributed to isolated participants; provisions may fall | Panel commentary, same event |
| Bank of England | £173bn of UK bank banking book exposure to private market funds and sponsor-backed leveraged corporates, or 8% of wholesale committed limits | SWES information gathering; scenario phase launched June 2026 |
| European Central Bank | Emerging financial stability risk; on-site inspections of bank exposures | Inspections commencing March 2026 |
| Fitch Ratings | US private credit default rate at a record 6% for the trailing twelve months, from 5.7% in the prior quarter | Q2 2026 data across roughly 1,300 tracked borrowers |
Source: Morgan Stanley European Financials Conference coverage, March 2026; Bank of England private markets SWES materials and Treasury Committee correspondence; ECB supervisory commentary; Fitch Ratings private credit default rate, Q2 2026, reported via Bloomberg and Investment Executive.
A closer look at the sector data
Fitch’s second-quarter data has been read almost entirely through its headline: a record trailing twelve-month default rate of 6% across roughly 1,300 tracked US private credit borrowers, up from 5.7%.
The composition tells a different story. More than half of those events were maturity extensions rather than missed payments, which is a lender and a sponsor agreeing that time is the cheapest available solution rather than a borrower failing to pay.
More striking is where the deterioration was not. The sector the market had fixated on, technology and software, recorded the lowest default rate among the largest sectors at 1.2%, down from 2.3%. Healthcare and industrials were where performance actually weakened. That said, this is a single quarter in a sector evolving faster than almost any other, and one good quarter is not a verdict. Caution remains warranted.
Worth noting as an observation: European direct lending default rates remain markedly lower, at around 2% by count in 2025 on KBRA’s data, with a modest rise expected this year. Some of that is a shallower recent vintage and a more conservative structuring culture. Some of it is a measurement question, since European practice leans towards amendment and extension, and whether that registers as a default depends on the framework counting it.
What This Means for You
In a market where every lender is being asked by its own risk function to justify new exposures, being the boring borrower has become a pricing advantage. Documented cash conversion, defensible add-backs, timely management information and a credible plan for the next eighteen months are worth real basis points, not just goodwill. The other move worth making now, while conditions are calm, is widening your lender relationships beyond the incumbent. Optionality negotiated from a position of strength is inexpensive; optionality sought during a wobble is not.
Where I Land
Bank chief executives are right that a European banking crisis originating in private credit fund losses is unlikely. The exposures are senior, the collateral is decent, the capital positions are strong, and the arithmetic does not currently support the more alarming versions of this story.
The risk that actually matters for British and European mid-market businesses is not that a bank fails because a credit fund did. It is that credit availability for perfectly sound companies tightens quickly and simultaneously, because a large number of institutions independently conclude that this is the year to be careful. That is a real economy risk, it lands on borrowers first, and no stress test currently measures it.
Read the poll and the panel together and they were not really disagreeing about the facts; they were disagreeing about whose problem this is. For a business that needs to borrow, that distinction matters rather less than it might appear. Either reading points towards a market where uncertainty tends to make liquidity harder to come by, and it is the borrower who feels that first.
Scott
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Frequently Asked Questions
What is a system-wide exploratory scenario, and does it have any teeth?
It is an exercise designed to understand how the financial system behaves collectively under stress, rather than whether any single firm survives. It carries no capital consequences and participation by non-banks is voluntary, so its power is informational rather than punitive. Its real effect is that it forces participants to articulate, in advance, how they would behave in a severe downturn.
Should I be worried that my private credit lender is about to pull my facility?
Committed facilities are contractual and do not evaporate because sentiment turns. The more realistic risks are at the margins: appetite for incremental facilities, willingness to grant waivers or amendments, and the terms available at refinancing. Those are the points at which a lender’s own pressures become visible to you.
Are European default rates genuinely lower than American ones?
Reported rates are lower, and part of that reflects real differences in vintage and structuring discipline. But European workout practice favours amendment and extension over enforcement, and whether an extension counts as a default depends on the measurement framework applied. Treat the gap as partly real and partly definitional.
What does the £173bn of UK bank exposure actually consist of?
It is banking book exposure to private market funds and to highly leveraged corporates backed by financial sponsors, covering facilities such as subscription lines, fund-level leverage and direct lending to sponsor-owned businesses. A substantial portion is undrawn commitment rather than deployed capital, which is one reason the aggregate figure overstates the immediate risk.
What should a CFO do differently this year because of any of this?
Start financing conversations earlier, tighten the quality of the information pack before anyone asks for it, understand which capital pool sits behind each of your lenders, and use a calm market to build relationships you may want in a difficult one. None of that is dramatic, and all of it compounds.
About the author: Scott Townsley originates and structures private credit transactions for lower- and mid-market businesses across the UK and Europe, working alongside management teams and sponsors to secure financing where bank and public markets fall short. Get in touch · Subscribe.
Sources: Morgan Stanley Research, coverage of the European Financials Conference and accompanying investor poll, March 2026; Bank of England private markets system-wide exploratory scenario launch and scenario phase materials, December 2025 and June 2026, and correspondence with the House of Commons Treasury Committee; Bank of England Financial Stability Report, July 2026; European Central Bank supervisory commentary on private credit exposures; Financial Stability Board, Report on Vulnerabilities in Private Credit, May 2026; Fitch Ratings private credit default rate data for the second quarter of 2026, reported via Bloomberg and Investment Executive; KBRA Direct Lending Deals European direct lending default rate data, as cited in the Association for Financial Markets in Europe’s European High Yield, Leveraged Loan and Private Credit Report, 2026. Figures originally reported in US dollars have been converted to sterling at an approximate August 2026 rate of £1 to $1.36 where applicable, and are rounded. Views expressed are the author’s own and do not constitute investment advice.