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FRM Exam Part II · The Global Drivers of Private Credit

What Is Private Credit and Its Market Structure

Updated 11 October 2026 · Fact-checked

Private credit is debt lent to companies by non-bank lenders, mainly funds, and held privately rather than traded on public markets. Main strategies are direct lending, mezzanine, distressed and special situations. Loans are negotiated bilaterally, often floating-rate, illiquid and held to maturity. The market grew as banks pulled back after the 2008 crisis.

Understand What Is Private Credit and Its Market Structure

Private credit is lending by non-bank institutions, usually funds, to firms through privately negotiated deals. The loans are not issued in public bond markets and are not syndicated to a wide pool of traded investors. The lender typically holds the loan to maturity.

The main strategies sit along a risk and return ladder. Direct lending is senior, often secured, floating-rate lending to mid-sized firms, many owned by private equity sponsors. Mezzanine sits between senior debt and equity. It is subordinated, pays higher interest, and may carry equity warrants or payment-in-kind (PIK) interest. Distressed investing buys the debt of stressed or defaulted firms at a discount, aiming to profit from recovery or restructuring. Special situations targets event-driven or complex needs, such as bridge financing, carve-outs or recapitalisations.

Compare with the alternatives. A bank loan sits on the bank balance sheet, funded by deposits, and is subject to bank capital and liquidity rules. A syndicated loan is arranged by banks and sold to several lenders, and it can trade in a secondary market. A public bond is rated, standardised and traded. Private credit trades speed, certainty of execution, flexibility and tailored covenants for a higher yield, called an illiquidity premium, and for less transparency.

Growth has two sides. On the supply side, stricter bank capital rules after the 2008 crisis made some leveraged lending less attractive for banks, while institutional investors such as pensions, insurers and sovereign funds searched for yield. On the demand side, private equity sponsors and mid-sized borrowers wanted certainty and speed. Banks have not disappeared: they often lend to private credit funds and partner with them, which links the two sectors.

For the exam, remember that the key risks are credit risk, valuation uncertainty, illiquidity and leverage at fund level. Do not memorise market-size figures; know the direction of growth and the reasons for it.

Key formulas to remember

Illiquidity premium
Private credit yield ≈ comparable public credit yield + illiquidity premium + complexity premium
A conceptual relationship, not a computed identity. Higher yield compensates for illiquidity, limited transparency and bespoke terms.
Seniority ladder (loss order)
Senior secured debt → unitranche → mezzanine → equity
Losses hit equity first, then mezzanine, then senior. Higher in the ladder means lower expected return and lower risk.
Floating-rate all-in coupon
Coupon = reference rate + spread
Direct loans are usually floating. Rising reference rates raise borrower interest burden and default risk.
Interest coverage ratio
ICR = EBITDA ÷ interest expense
Common covenant and stress metric. A lower ICR signals weaker ability to service debt.

How to solve What Is Private Credit and Its Market Structure questions

Use this approach for any question on the definition, strategies or structure of private credit.

  1. 1Identify what is asked: a definition, a strategy match, a comparison with banks or public markets, or a growth driver.
  2. 2Locate the position in the capital structure: senior, subordinated or equity-like.
  3. 3Check who the lender is and how the loan is held: a fund holding to maturity, or a bank syndicating it.
  4. 4Note the rate type, collateral, covenants and liquidity of the instrument.
  5. 5Match the strategy: senior floating loan to a sponsor-backed firm is direct lending; subordinated with warrants or PIK is mezzanine; discounted debt of a stressed firm is distressed.
  6. 6Check growth-driver wording: bank retrenchment and regulation are supply-side shifts for banks; yield-seeking investors are supply of capital; sponsors needing certainty are demand.
  7. 7Eliminate options that overstate, such as saying private credit is risk-free, always senior or fully liquid.
  8. 8Pick the option that states the trade-off: higher yield for lower liquidity and transparency.

Quickest way: Three-question strategy match

When to use it: For multiple-choice questions asking which strategy or structure a scenario describes.

  1. Ask: is the borrower healthy or stressed? Stressed or defaulted points to distressed.
  2. Ask: is the claim senior or subordinated? Subordinated with equity kicker or PIK points to mezzanine.
  3. Ask: is it a standard sponsor or mid-market loan? Then it is direct lending; a one-off event-driven need is special situations.

Common mistakes in What Is Private Credit and Its Market Structure

  • Treating private credit as the same as syndicated bank loans.

    Both are loans to corporates and can look similar.

    Fix: Remember who holds the loan. Private credit is negotiated with a small group of non-bank lenders and held; syndicated loans are arranged by banks and can trade.

  • Assuming all private credit is senior and safe.

    Direct lending is the largest strategy, so it is assumed to represent everything.

    Fix: Mezzanine is subordinated and distressed buys stressed debt. Always check seniority.

  • Confusing mezzanine with distressed debt.

    Both carry high returns and high risk.

    Fix: Mezzanine is a structural position in a healthy firm's capital structure; distressed is about the borrower's condition.

  • Saying banks have left the market.

    Growth of non-bank lenders is read as full replacement.

    Fix: Banks still lend to private credit funds, provide leverage and share deals, so the sectors are interconnected.

  • Quoting market-size numbers from memory as facts.

    Headlines give figures that vary by source and date.

    Fix: Focus on drivers and direction of growth. Answer using concepts unless the question gives numbers.

  • Believing the illiquidity premium is free return.

    Higher yield is seen as better performance.

    Fix: It compensates for lack of liquidity, opaque valuation and bespoke terms. It is a cost of bearing risk.

Worked examples

Example 1

A fund lends to a private-equity-owned manufacturer. The loan is senior, secured, floating-rate at reference rate + 6%, negotiated bilaterally, and held to maturity. Which strategy is this, and which feature mainly distinguishes it from a syndicated loan?

Show the solution
  1. Senior, secured, floating-rate lending to a sponsor-backed firm is the standard profile of direct lending.
  2. A syndicated loan is arranged by banks and distributed to multiple lenders who can trade it.
  3. Here the loan is negotiated bilaterally with a non-bank fund and held to maturity.
  4. So the distinguishing feature is private negotiation and holding, not seniority or rate type.

Answer: Direct lending; it is privately negotiated and held by a non-bank lender rather than syndicated and traded.

Example 2

A lender holds a ₹100 crore loan to a firm whose EBITDA is ₹60 crore and annual interest is ₹12 crore. Reference rates rise so that interest becomes ₹15 crore, EBITDA unchanged. Compute the change in interest coverage and state the implication for a floating-rate private loan.

Show the solution
  1. Initial ICR = 60 ÷ 12 = 5.0.
  2. New ICR = 60 ÷ 15 = 4.0.
  3. Coverage falls by 1.0, from 5.0 to 4.0.
  4. Floating-rate coupons pass rate rises to the borrower, so credit risk rises even with no change in earnings.

Answer: ICR falls from 5.0 to 4.0; rising rates raise borrower default risk on floating-rate direct loans.

Exam tips

  • Expect scenario questions that describe a loan and ask you to name the strategy. Read seniority and borrower health first.
  • Know the contrast with banks and syndicated loans: holder, liquidity, regulation, and execution speed.
  • Link growth to post-crisis bank regulation and investor search for yield, not to a single cause.
  • Watch for absolute words such as always, never or risk-free; they usually signal a wrong option.
  • If asked about risks, name illiquidity, valuation opacity, credit risk and fund leverage.

Practice questions from The Global Drivers of Private Credit

What Is Private Credit and Its Market Structure in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

What Is Private Credit and Its Market Structure: frequently asked questions

What is private credit in FRM Part II?

It is non-bank, privately negotiated lending to firms, typically through funds that hold loans to maturity. It appears in the Current Issues readings on private credit. Know the strategies, growth drivers and risks.

What is the difference between private credit and syndicated bank loans?

A syndicated loan is arranged by banks and sold to several lenders, and it can trade in a secondary market. Private credit is negotiated with a small group of non-bank lenders and usually held to maturity. Private credit offers speed and tailored terms, but it is less liquid.

What are the main private credit strategies?

Direct lending is senior lending to mid-sized firms. Mezzanine is subordinated debt, often with equity features. Distressed buys the debt of stressed firms, and special situations covers event-driven financing.

How big is the private credit market globally?

Estimates vary by source and definition, so do not rely on a single figure. For the exam, know that the market has grown strongly since the 2008 crisis, driven by bank retrenchment, investor demand for yield and sponsor demand for financing.