The Collapse of the Hidden Banking System Is Underway

The hidden banking system is growing fast. It now controls about $3 trillion in loans. Many of these loans go to companies already in trouble. Nearly half of these borrowers can barely pay their interest. This creates a risk that can spill back into regular banks and into everyday savings and investments.

This hidden system is often called private credit. Private credit funds are not banks. They are investment funds that lend money to companies. They do not follow the same strict rules as banks. After the 2008 crisis, banks faced tighter laws to limit risky lending. Private credit grew by stepping into that gap. While the loans sit outside banks, many banks lend money to these private credit funds. That means bank balance sheets are still tied to the risk.

Here’s why this matters. If private credit borrowers default, the funds take losses. If funds take losses, they may struggle to repay banks. Those losses can then hit banks. This chain is called “contagion.” It means trouble in one part of the system spreads to another part.

Key terms explained in plain language:

• Private credit: Lending done by investment funds, not traditional banks. Fewer rules. Less public reporting.
• Leverage: Borrowing money to invest more. For example, a company that earns $100 and owes $560 is 5.6 times leveraged. Higher leverage means higher risk.
• Default: When a borrower can’t meet interest or principal payments on time.
• Contagion: When financial losses spread from one area (like private credit) to another (like banks).
• VIX: A market “fear” index. Higher readings mean markets expect more volatility.

What looks similar to 2008? Back then, banks made risky loans and hid them in complex products. Ratings made them look safe—until they weren’t. Today, private credit funds value many of their loans themselves. There is little oversight. The system looks stable—until defaults rise. Then the true value of these loans shows up quickly, and it can be painful.

What can ordinary investors do?

• Do not try to predict the exact timing. Prepare instead. No one knows when stress will show up.
• Prefer assets over too much cash. Inflation quietly reduces cash value over time.
• Use a simple three-tier portfolio approach:

1. Core, high-quality assets: Broad index funds and large-cap stocks. These can fall in a crisis but have a history of recovery.
2. Inflation hedges: Assets that may hold value if prices rise. Examples include gold and select real estate (be cautious with debt-heavy or office-focused real estate).
3. Satellite positions: Smaller, focused bets such as individual stocks, themes (like energy or AI), or options if you truly understand them. Keep this a small slice.

Set sell rules. Decide in advance when to take profits or cut losses. Hope is not a strategy.

Watch simple warning signs:

• Rising default rates among risky borrowers
• Funds limiting or suspending withdrawals
• VIX staying above 30 for a period

What to avoid or handle with care:

• Long-term government bonds when inflation is high
• High-yield (junk) bonds closely tied to risky corporate borrowers
• Heavy leverage (including leveraged ETFs) if you don’t fully understand the risks
• Individual bank stocks without strong risk controls
• Private credit funds with long lockups and little transparency

In short, the hidden banking system has grown large and intertwined with regular banks. High leverage and weak borrowers make the system fragile. A smart plan focuses on strength in core assets, selective inflation protection, and a small, controlled set of higher-risk ideas. Clear rules and steady behavior can help investors face shocks without panic.

Readers who want to learn more about the people behind this education can explore Felix Prehn’s work with Goat Academy here: Felix Prehn Goat Academy.