Banks and the not so 'hidden' exposure to private credit

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A few credit blips tied to private credit and bank loans to nonbank financial institutions have weighed on the bank group recently and come at the same time the group faced pressure over concerns that greater adoption of AI could threaten many traditional jobs and ultimately lead to higher levels of unemployment. However, some bank analysts argue that both issues might be overblown and that AI in particular could lead to efficiency gains for banks.

Bank stocks have fallen more than 10% since the recent peak, with regional banks slightly underperforming their larger counterparts. A handful of losses in the private credit space and gating of redemptions at business development companies weighed on the group as some investors questioned whether banks could have greater credit risks than previously realized, given the strong growth in loans to nondepository financial institutions over the last year. That pressure grew after a Citrini Research report outlined a fairly doomsday economic scenario of what could go wrong if successful AI adoption has overly negative side effects, and only grew further after US and Israeli tensions with Iran escalated to war and sent oil prices far higher.

The conflict in the Middle East has persisted, but fears that banks do not have a handle on their private credit exposures likely are misunderstood, according to Greg Hertrich, managing director and head of US Depository Strategies at Nomura.

Click here to access a transcript of the episode.

Hertrich argued in the latest Street Talk podcast that banks' exposure to nondepository financial institutions is not a time bomb waiting to be discovered. He noted that bank managers and their regulators have paid close attention to the growth in those portfolios, which accounted for close to half of the growth in the banking industry's loan growth in 2025. Hertrich further noted that bank loan portfolios are backed by much stronger capital and higher levels of reserves, and institutions operate with lower loan-to-values and meaningfully different credit culture than in prior stress cycles.

"How concerned am I about it? I don't think that it would rise to a top three. I do think that it is an area that bankers have paid a lot of attention to, and I think rightfully so because it is relatively new," Hertrich said in the episode. "For most of the banks that we interact with, there would have to be a very significant and permanent loss associated with some of the end credits before any of it became sort of a banking issue, even for individual bank balance sheets."

He further noted that the credit culture has changed at many banks, and growth is no longer the main focus for institutions as it was before the financial crisis. He said that it would have been extraordinarily rare for members of a bank C-suite to talk about losing business to a competitor or nonbank lender before the Great Recession, but that is commonplace now.

"I think this speaks to that sort of cultural shift post Dodd-Frank. I think what you're hearing now is we know where in the capital stack we want to be," Hertrich said.

He also noted that some investor concerns might be misplaced, as they could confuse credit risk with liquidity and asset-liability mismatches. He said that many private-credit holders, such as insurance companies and asset managers, might be structurally better suited to hold longer-duration assets because their liabilities do not behave like bank deposits. That distinction matters when markets start questioning which institutions are holding the bag and whether stress, if it comes, is more about funding and liquidity mechanics than outright losses.

"If you've got longer duration liabilities, in theory, you can afford to take a little bit more asset duration," Hertrich said. "The liability stream is not like it is at the banks."

Hertrich also discussed the implications of AI transforming the economy and the banking business. He suggested that banks might actually be among the best-positioned institutions to benefit from the technology, not just survive it. He noted that banks have repeatedly absorbed "tectonic shifts" such as the emergence of credit cards, online banking and mobile banking, and emerged more productive, not obsolete. He expects early AI gains to show up in process-heavy back-office and regulatory workflows, with management teams moving carefully to test, retest and then check results with regulators, but not treat adoption as a decade-long project. Longer term, he said, greater AI adoption could lead to better transparency and capital allocation across businesses, and ultimately spur other forms of expansion that do not threaten the economy.

"An analogy that resonates for me is artificial intelligence and the transcontinental railroad build-out. Certainly, in the immediacy, terrible for buggy whip makers, right? But over the long haul, a couple of things came out of that, not the least of which was the development and maintenance of an entire nation of smaller cities, sort of, besides New York and San Francisco. That was, I'm sure, unimagined when they started putting rails down," Hertrich said.