How Private Credit Works: Loans, Funds, and Liquidity
To understand private-credit liquidity, follow one loan from negotiation to repayment and then follow the capital that funded it. This chapter focuses on two linked designs: the direct loan, which a private lender generally keeps on its balance sheet, and the investment vehicle, which determines when its own investors can ask for cash. That distinction helps the reader judge where liquidity pressure can enter the chain without mistaking a fund’s redemption promise for liquidity in the underlying loan.
A direct loan is a relationship that persists
A direct loan begins with a bilateral negotiation between a borrower and a specialized lender. The borrower may want a structure tailored to its cash flows, a faster execution process, or terms that a standardized market would not provide. The lender sets an interest-rate spread, maturity, covenants, and other conditions, then records the loan as an exposure to that company. In the loan-level data used by the BIS, a direct loan remains active until it matures. That is different from a syndicated or leveraged loan that can be arranged by an investment bank and then distributed or traded among a large group of investors.
The distinction is more than a matter of paperwork. A lender that keeps the loan until maturity remains exposed to the borrower’s ability to generate cash throughout the life of the contract. A change in earnings, interest costs, or refinancing conditions therefore affects the lender even if no secondary-market price is available to signal the change. The same arrangement can support patient monitoring and renegotiation, but it can also make the asset difficult to sell when the lender or its investors need liquidity. “Private” does not mean that the loan is inactive; it means that the relationship is negotiated and held in a less continuously traded setting.
The contract is a set of controls around that exposure. Floating-rate terms pass changes in reference rates through to the borrower, while covenants and other contractual protections give the lender information or rights when the borrower’s condition changes. None of these features guarantees repayment. They determine who has information, who can respond early, and who bears the residual loss after the borrower’s cash flows prove insufficient.
The lender’s return comes primarily from the interest spread and the eventual repayment of principal. The borrower pays for access to capital and for the flexibility of the arrangement. A riskier or less transparent company may be willing to accept that price because alternatives are limited or less adaptable. For the fund, the return must compensate for the possibility that a loan remains on the books while the borrower’s business weakens. That is why the private-credit model cannot be understood only by looking at the amount lent. One must also ask how long the exposure lasts, how it is priced, and what rights the lender has if the borrower’s condition deteriorates.
A deal can also contain more than one lender. In a club deal, several lenders finance the same borrower, and the exposure is divided among them. This can allow a larger or more complex financing package without turning the loan into a fully public security. It also creates a shared-obligor relationship: a problem at one borrower can appear on several lenders’ books at once. The presence of multiple lenders changes the network around the loan, even if the borrower still experiences the arrangement as one financing package.
The loan’s lifecycle therefore has two simultaneous perspectives. From the borrower’s perspective, it is a source of funds followed by interest, covenant compliance, and principal repayment. From the lender’s perspective, it is an asset whose value depends on cash flows, contractual protections, and the ability to respond to new information. From the investor’s perspective, it is an indirect claim on that asset through a fund or BDC. A useful analysis keeps these perspectives separate before asking how they interact.
The question of who owns the exposure also clarifies who can make a decision when conditions change. The borrower controls the business that generates the repayment cash flow. The lender controls the contractual relationship and decides how to respond when information changes, subject to the agreement. The fund or BDC controls the portfolio-level choices that determine how one loan sits alongside many others. Investors own a claim on the vehicle, not a claim that can normally be redeemed directly against one particular borrower. These are different layers of ownership and decision-making, even when the same cash flow supports all of them.
Consider an ordinary period. A borrower draws the loan, uses the funds for its business, and makes scheduled interest or principal payments. Those payments become cash for the lender and, through the fund, part of the resources supporting investor returns. If the lender holds the loan to maturity, it does not need a daily market buyer to preserve the contractual relationship. That is one reason private loans can be held patiently. But the same absence of a continuously traded price means that a change in the borrower’s prospects may first appear through monitoring, a covenant issue, or a revised valuation rather than through an immediately visible market quotation.
Now consider a change in the borrower’s condition. A missed payment is not the only possible stress point; a weakening business can first affect the lender’s judgment about future cash flows. The lender may have contractual rights or may seek a renegotiation, but neither response guarantees that the borrower will recover. If several lenders share the same borrower, the information and decision problem is distributed across institutions. A club structure can spread the amount of one loan, but it can also make the same borrower’s deterioration appear in several portfolios. That is a different kind of diversification from holding unrelated borrowers.
This is why a private-credit lifecycle should be read as a sequence of claims, not as a single transfer of money. The borrower receives financing; the lender carries credit exposure; the vehicle aggregates that exposure with other loans; and the investor receives a claim whose liquidity depends on the vehicle’s rules. The next layer of the system begins when the investor’s claim can mature or be redeemed on a schedule that does not match the borrower’s loan maturity.
Liquidity is a promise layered on top of the loan
The investor who supplies capital to a private-credit vehicle does not necessarily receive the same liquidity that would be available in a public bond fund. Traditional private-debt funds commonly lock institutional capital for seven to ten years and do not offer an option to redeem it during that period. The stable funding is useful to a lender holding loans that may not be easy to sell. Investors accept the restriction in exchange for access to a private lending strategy and its expected income and risk exposure.
Other vehicles change that bargain. A BDC with limited or no investor redemptions offers a different funding promise from a non-traded or semi-liquid vehicle that allows investors to request cash at scheduled intervals. The underlying loans do not become liquid merely because the vehicle offers an exit window. The vehicle must meet a cash request with some combination of new inflows, borrower repayments, cash or more-liquid holdings, borrowing, asset sales, or a decision to limit the redemption.
The Federal Reserve’s estimates show why this structure matters. In the second half of 2025, perpetual-life BDCs had about $306 billion in gross assets and $161 billion in net assets. They raise capital continuously and generally offer quarterly redemptions, with many disclosing an intention to cap total redemptions at 5 percent of net asset value per quarter. Interval funds had about $119 billion in gross assets and $80 billion in net assets. They raise capital continuously as well, offer redemptions at specified intervals, and are generally required to accept at least 5 percent of requests. Together, these semi-liquid categories represented $425 billion in gross assets and $241 billion in net assets, or about one-fifth of net assets under management in private-credit vehicles.
Gross assets and net assets answer different questions. Gross assets describe the size of the portfolio before subtracting liabilities; net assets describe the value left for equity investors after those liabilities. Neither number tells us how quickly the loans can be sold or how much cash is available today. A redemption cap is a rule about how much the vehicle may have to return in a period, not a guarantee that the portfolio can be liquidated at an unchanged price. That is why the vehicle’s funding design matters alongside the quality of its loans.
The difference between the two semi-liquid designs is a difference in who bears the timing risk. A perpetual-life BDC can raise capital continuously and offer quarterly redemptions, but the reported 5-percent figure is generally an intended cap and managers can decide whether to accept more or fewer requests. An interval fund also offers periodic access, but the Federal Reserve notes that it is generally required to accept at least 5 percent of redemption requests. Neither rule says that five percent of the portfolio can be sold at a stable price every quarter. The rule determines the vehicle’s obligation; the cash sources determine whether that obligation can be met without reducing other activities.
This makes a fund’s liquidity a moving balance rather than a fixed label. New investor inflows add cash, while borrower repayments release cash from the loan portfolio. More-liquid holdings can be sold more readily than a bilateral loan, and a bank line can provide temporary borrowing capacity. But each source has a condition. Inflows depend on investor demand, repayments depend on borrowers, liquid assets may have to be sold at a changed price, and borrowing creates a bank claim that must later be repaid. The vehicle is resilient when these sources arrive in a pattern that matches the timing and size of redemptions. It is more constrained when they all weaken together.
The first-quarter-2026 experience illustrates the distinction between pressure and failure. Redemption requests increased as sentiment deteriorated, and accepted redemptions somewhat exceeded new inflows for the first time since perpetual BDCs were created. Most managers applied the 5-percent cap. The Federal Reserve judged the associated stability risks limited and manageable under the conditions it observed, partly because of available bank credit and cash. That conclusion does not mean the structure is immune to a more persistent mismatch. It means that the reported buffers were sufficient for the measured episode and that the managers used a contractual tool designed for precisely this situation.
A bank revolving line can provide another buffer. The Federal Reserve identifies several sources that semi-liquid funds can use to manage redemptions: investor inflows, regular principal repayments, bank revolving lines, and more-liquid assets such as leveraged loans. For the ten largest perpetual BDCs, which represented about 80 percent of the sector’s assets in the report, available bank credit and cash could cover at least three calendar quarters of net redemptions up to the 5-percent net-asset-value level. This is evidence of capacity under the conditions and assumptions reported; it is not a promise that repeated or much larger requests would be equally easy to meet.
The bank line also shows why liquidity is not confined to the fund. If a vehicle draws on a committed facility, the bank becomes a counterparty to the vehicle’s need for cash. If the vehicle sells an asset, another investor or lender absorbs the exposure at a price that may reflect the stress. If the manager limits redemptions, investors bear the cost through delayed access to their money. The same request can therefore redistribute pressure among investors, the fund, banks, and borrowers rather than make the pressure disappear.
The sequence has an important asymmetry. The borrower’s loan is a multi-year claim, while the BDC investor’s redemption right arrives at a scheduled interval. The mismatch may be manageable when repayments and new inflows are steady. It becomes more demanding when sentiment turns negative, several investors request cash together, or the underlying borrowers need more time rather than less. The existence of a cap can protect the vehicle from an immediate run, but it can also leave investors waiting and reduce the flow of new credit to borrowers.
This is the trade-off created by broader access to private credit. Stable, locked-up capital better matches the maturity of private loans, but it limits investor access. Semi-liquid structures broaden the investor base and offer periodic liquidity, but they add a promise that must be met with resources that are not perfectly liquid. The Federal Reserve reported that redemption requests increased as sentiment weakened and that accepted redemptions exceeded new inflows in the first quarter of 2026 for the first time since these vehicles were created. Most managers capped redemptions, and the report judged the near-term stability risks limited and manageable under the observed conditions. The relevant conclusion is not that a crisis had begun. It is that the funding design had become an active part of the market’s risk profile.
A final distinction keeps the measures in order. Gross and net assets describe the vehicle’s balance sheet. A bank commitment describes available credit, not necessarily a drawn amount. A redemption request describes an investor’s demand for cash, not a loan default. A delinquency or impairment measure describes realized or recognized credit deterioration, not every future vulnerability. Confusing these measures can make a fund look safer or more fragile than the evidence supports.
The loan and the vehicle are therefore two layers of the same system. The loan creates a long-lived credit exposure; the vehicle decides how patiently that exposure can be funded. The next question is what the lender asks the borrower to pledge when information is imperfect—and why that choice can tie private-credit supply to the value of collateral and the wider credit cycle.