Recession Watch: Private Credit Bubble Threatens the Mega-Banks

One of the selling points of “real” banks like JPMorgan Chase or Bank of America is that they’re immune to the debauchery of the private credit “shadow banking system.”

But it turns out that mainstream banks have also been feasting on those fat private credit fees and high loan rates. And now they’re reaping that particular whirlwind. Here’s the story:

The FDIC issues a warning about an increasing risk in big banks

(Kitco) - Over the past twelve months, the Fed and other regulators have published multiple pieces highlighting major risks to the banking system - often in sharp contrast to what bank CEOs and large-banks analysts are saying.

According to the report, bank lending to Nondepository Financial Institutions (NDFIs), or shadow banks, has been the fastest-growing loan segment since the GFC, and the banking industry continues to increase its exposure to nonbanks. In 2025, these loans grew by 35% YoY, while the chart below shows the compound annual growth rate from 2010 to 2025. Since 2012, loans to shadow banks have grown by 26% per year, according to the St. Louis Fed. History suggests that such explosive growth has often preceded a crisis.

Unsurprisingly, loans to shadow banks are heavily concentrated among the largest banks. At year-end 2025, 86% of this portfolio was held by banks with more than $100B in assets, and ten of those banks held about 66% of all loans to shadow lenders.

The FDIC explicitly highlights the risk, noting that, in an economic downturn, shadow lenders may need to sell assets, putting downward pressure on asset values. This could affect the valuation of assets pledged as collateral or held by other shadow lenders and banks. NDFIs, or shadow banks, that rely on less stable funding sources could also face significant liquidity stress because of margin calls on collateral pledged under their bank facilities. This could increase liquidity demands on banks as NDFIs collectively draw on bank-funded credit lines to safeguard their operations, while individual NDFI borrowers may find themselves without access to funding.

Why, then, is lending to shadow banks growing so rapidly? The most likely answer is that, because of limited regulation, these loans are extremely profitable for banks. Despite repeated warnings from regulators that shadow banking poses a key risk to global financial stability, banks - especially US banks - allocate relatively little capital when extending these loans. In fact, the broad deregulation of the US banking industry in 2025-2026 freed up a substantial amount of capital, much of which appears to have been directed toward shadow banks, as reflected in the 35% YoY growth rate.

The rapid growth of bank lending to shadow lenders has created a large and increasingly concentrated source of risk within the financial system. These exposures may appear profitable in normal conditions, but in a downturn they could amplify liquidity stress, collateral losses, and funding pressure across both banks and nonbanks. With regulation becoming less restrictive, this risk deserves much closer attention.

Enter the Hyperscalers

Meanwhile, it turns out that most of the recent shadow bank lending has been to “hyperscalers,” companies like Amazon, Alphabet, and Meta that are racing to build AI data centers. And that market has taken a sudden turn for the worse.

The following chart requires a bit of explanation. The red line is credit spreads (inverted) for the hyperscalers. When it falls, that means credit spreads (the difference between what a hyperscaler has to pay to borrow versus what the US Treasury pays) are widening.

The blue line shows the aggregated share price for hyperscaler stocks. Note that in just the past few weeks, those stocks have begun to roll over while credit spreads have spiked.

Here’s a video that names names:

The result? Falling share prices slam into a mountain of overoptimistic debt, sending hyperscaler credit spreads parabolically higher and their shares sharply lower. The AI bubble bursts, taking down not just the hyperscalers but their too-big-to-fail bank creditors.

To say this might cause a recession grossly understates the current risk.