The Office of the Comptroller of the Currency (OCC) is aiming to reinvent how it supervises banks — shifting from a “check-the-box” compliance approach toward one that focuses on the biggest, most complex financial threats. This change couldn’t come at a more critical moment.

Because as the OCC sharpens its focus, markets are showing early cracks in what many believed to be one of the most attractive and fastest growing corners of the investment universe — private credit.

JPMorgan’s Jamie Dimon recently warned about “the first private-credit cockroaches” (following the bankruptcies of Tricolor Holdings and First Brands). It’s an unsettling metaphor, but an accurate one. The point isn’t just that a few defaults are appearing — it’s that the system could be hiding many more. Joshua Easterly of 6th Street put it best: “In private credit, you have to be right 99 percent of the time — there’s almost no upside, and missing once can wipe you out.”

That’s the statistical nature of private credit: low volatility in good times, but potentially extreme losses in bad ones. And as Rick Bookstaber, former CRO of Salomon Brothers and former senior risk manager at Bridgewater Associates and Morgan Stanley, reminds us, “The biggest hit might not be the one everyone’s watching — it’ll be the one tied by invisible threads to the market no one can get out of.” Those “invisible threads” — correlations, funding dependencies, and liquidity mismatches — are exactly what risk managers and supervisors must now try to uncover.

At the same time, the OCC itself is reportedly losing some of its most experienced Risk Analytics professionals. That’s a worrying sign just as supervision needs more analytical depth, not less. Add to that the latest deregulatory shift that could unlock $1 trillion in new bank lending capacity, and the landscape looks even more fragile.

Why? The private-credit boom largely happened because banks were constrained by capital charges. Once those constraints ease, lending patterns might dramatically change. If private credit funds face increasing withdrawals, the appeal of private credit as an investment will diminish. In turn, banks lending to these funds would find themselves exposed to struggling counterparties.

The contagion channel here could be CLOs (collateralized loan obligations). Even without a single default in the underlying loans, higher correlations or lower liquidity could force senior tranches to be downgraded to junk. That would mean higher capital requirements for banks and insurers, more forced sales, and — potentially — a system-wide liquidity crunch.

So how do we get ahead of that?

By changing how we think about stress testing. Not by making it stricter or softer — but by making it more constructive and informative. The OCC and other regulators could use full-range scenario analysis — a method that doesn’t just test one or two extreme cases but maps the entire spectrum of possible conditions. It connects the dots between market behavior, funding risks, and investor reactions.

Such an approach would help identify where hidden financial threads might exist, what could pull on them, and how to spot early warning signs before they tighten.

Because the next crisis may not look like 2008 or 2023. It may start in a corner of private credit, travel through CLOs, and end up challenging the very liquidity and confidence that keep the financial system together.

And that’s exactly why reinventing supervision — and building transparency into stress testing — matters right now.

Source: Linkedin – Alla Gil