Private Credit in India: What Filled the Gap Banks Left

Key Takeaways

• Private credit has emerged as a separate asset class in India that is addressing the financing gap left by traditional lenders.

• Its ability to offer structured financing tailored to the unique needs of businesses with irregular cash flows makes it an attractive long-term funding partner.

• However, private credit in India has developed during a period of robust economic growth. Its risk tolerance is yet to be tested in a significant downcycle.

• Banks, NBFCs, and mutual funds have built their lending policies based on lessons from their past experiences.

India’s credit landscape largely favours creditworthy companies and lower-risk projects. Tightening regulations by the Reserve Bank of India (RBI) are further distancing banks and Non-Banking Financial Companies (NBFCs) from mid-market and growth-stage Indian companies who need long-dated financing with repayment flexibility. Their complex financing needs simply do not fit within the standard lending structure of banks, creating a structural lending gap. That is why private credit is stepping in, and filling the structural and regulatory gaps left by banks.

Once perceived as a source of short-term finance for small, non-investment-grade firms, private credit is now financing billion-dollar investment-grade deals. Whether it is real estate land acquisition or infrastructure financing, private credit is filling gaps where conventional lenders have become more selective.

Take the case of the Shapoorji Pallonji Group, which completed multiple private credit deals totalling $3.4 billion in May 2025. The debt instruments used included three-year, zero-coupon rupee bonds with a yield of up to 19.75%.

Today, many real estate and renewable energy deals are financed through private credit as banks withdraw from certain financing segments. Such large deals are possible because private credit is institutionalised, with dedicated funds financed by sophisticated investors conducting their own due diligence and valuation of complex business activities.

These investors are compensated for the illiquidity and credit risk they take in this opaque market where many details remain private. The absence of a daily price is both a feature and a source of risk.

What exactly is Private Credit?

Private credit is a term that is loosely used for lenders who provide short-term loans to non-investment-grade firms. However, in wealth management, private credit discussions tend to refer to senior secured debt instruments extended by private credit funds.

Alternative asset managers raise long-term, locked-up capital from institutional investors and HNIs using closed-end private credit funds. These funds then lend directly to mid-market firms. The lending happens via bespoke instruments with customised terms and covenants and floating-rate structures. These tend to be unrated and do not trade in public markets.

Why did Banks Retreat from Mid-Market Lending?

Banks are typically known to dominate the world of credit, and when such lenders retreat, it is normal to ask why. What discouraged them from lending to this segment?

The traditional banking system in India has remained cautious following the period of high corporate defaults and legacy non-performing assets between 2013 and 2019. That experience forced banks to implement tighter capital adequacy norms, making unrated and mid-market loans expensive to maintain. Many banks have shifted their focus towards retail and small business lending as these loans are easier to underwrite and have lower capital adequacy requirements than complex corporate and infrastructure financing structures.

Not only did banks move towards easier loans, but they also standardised their loan policies, imposed caps on sector exposure, and became reluctant to finance unpredictable projects that cannot give real-asset collateral. Banks are also less likely to finance sunrise sectors such as artificial intelligence, new-age business models, and last-mile funding for cost overruns.

Going beyond commercial preferences and experience, certain regulations are pushing banks out of some segments. The RBI generally restricts banks from lending to private developers for land acquisition. The central bank also requires that equity capital be self-funded, restricting banks from financing mergers and acquisitions, in which one company acquires an equity stake in another company.

Standardized policies, regulatory changes and legacy NPAs have created a durable structural shift in bank lending. The borrowers who are left unserved or under-served by banks are turning to private credit. They are not distressed companies of last resort, but strong businesses that have legitimate capital needs and yet fall outside banks’ standardized lending policies.

For instance, in June 2025, Adani Airports Holdings Limited raised $1 billion through a project finance structure for development, modernisation, and capacity enhancement of Mumbai International Airport.

The Emergence of Private Credit as an Asset Class

The retreat of banks from wholesale lending and complex project financing structures has led to the emergence of private credit filling this structural capital gap. While companies with "AA" and "A" ratings are tapping debt capital from mutual funds and non-bank lenders, companies with lower credit ratings are increasingly tapping private credit.

Private credit is no longer merely a cyclical opportunity but has emerged as a distinct asset class addressing the capital needs that banking capital alone cannot fulfil. It caters to complex financing structures that require faster execution, longer repayment periods, and customized security arrangements. This flexibility in financing structures comes at a higher cost that borrowers should be willing to pay in exchange for access to capital.

Alternative asset managers pool money from a wider investor base of non-bank investors and deploy this capital after due diligence and valuation.

How are returns generated in a Private Credit fund?

Borrowers receive capital to continue their planned business activities and service the debt as projects come to fruition. Investors earn returns in the form of coupons, contractual interest payments, and origination or structuring fees, as specified in the lending terms. However, since these instruments are highly illiquid, they may be suitable only for investors who can commit long-term capital and have a high tolerance for risk.

Private credit funds typically target gross yields of around 12% to 24%, substantially higher than the yields generally available from banks (approximately 8% to 10%) and finance companies (around 10% to 13%). Actual returns vary significantly depending on the strategy, borrower quality, leverage, and market conditions.

According to the EY Private Credit Report for H2 2025, performing private credit strategies typically target internal rates of return (IRRs) of around 12% to 18%, while higher-yield or opportunistic strategies may target IRRs of approximately 18% to 24%.

Since private credit funds are not subject to the same prudential capital requirements as banks and NBFCs, they can offer customised structures and repayment schedules.

Such loans typically have a three-to-five-year tenure. Asset managers align loan disbursements with borrowers' capital expenditure plans, interest payments with projected cash flows, and repayments with expected refinancing events or funding milestones.

These complex financing structures may incorporate scheduled amortisation, step‐up interest rates, bullet repayments, equity warrants, convertible features, etc.

What is Venture Debt?

So far, we have discussed senior secured lending, which is one form of private credit. There are several sub-categories of private credit with varying degrees of risk, such as mezzanine debt and special situations debt. An increasingly important segment is venture Venture Debt, which generally carries higher risk range than senior secured lending.

Like venture capital , venture debt funds early-stage companies that have already raised Series A equity and need additional capital to fund growth, bridge to the next equity milestone, or meet working capital requirements.

What differentiates venture debt from senior secured loans is the underwriting approach and the equity kicker.

Lenders generally underwrite venture debt by evaluating the quality of existing investors, the company's growth trajectory, and the startup's financial discipline. Since high-growth startups are often not yet profitable, carry inherent risk, and frequently lack sufficient assets for collateral, interest income alone may not adequately compensate lenders.

Thus, many venture debt deals offer warrants, which give the lender the right to purchase a small equity stake at a pre-determined price, allowing them to participate in the company's future upside. Although venture debt can result in dilution through warrants, the dilution is typically between 0.1% and 2% of equity—significantly lower than that of a typical equity funding round.

Founders gain access to largely non-dilutive financing, while lenders receive contracted interest income to provide downside protection, along with warrants that allow them to participate in future equity upside.

What are the Risks involved in Private Credit?

Private credit is a lucrative alternative for sophisticated high-net-worth individuals seeking returns that may exceed those offered by traditional fixed income instruments. However, this alternative asset class also carries significant risks. Some of the most prominent risks are:

Credit Risk:

Many private credit borrowers are either unrated or have limited external credit coverage, meaning that credit risk depends heavily on the asset manager's underwriting standards and ongoing monitoring. Although lenders impose covenants to protect their capital, they may still suffer partial or permanent capital losses if a project underperforms and the borrower defaults. The private credit lender’s due diligence and credit assessment framework needs to be robust.

No Mark-to-Market:

Since private credit is typically extended through privately negotiated loans or unlisted debt instruments, there is no daily market price or NAV reflecting the value of these investments. If the underlying credit quality deteriorates, investors may not become aware of it until periodic valuation exercises or borrower reviews are conducted.

By that stage, recovery options may be more limited, and the investment may require a write-down or restructuring. While the absence of daily price fluctuations reduces short-term volatility, it also reduces price transparency, making continuous monitoring by the asset manager particularly important.

Concentration and J-Curve:

Concentration: The private credit market in India is still relatively small. It remains concentrated in sectors such as real estate, infrastructure, and structured mid-market corporate financing, where traditional lenders have become more selective. As a result, many private credit funds hold a relatively limited number of high-value investments, creating concentration risk.

J-Curve: Returns from private credit funds often follow the J-curve pattern, where returns are relatively weak or even negative during the initial years before improving over time. This is particularly common in closed-end funds, where capital is drawn down progressively rather than deployed immediately.

Initial returns may appear weak because capital is deployed gradually as suitable investment opportunities arise, rather than all at once. Borrowers also require time to deploy capital and begin generating the cash flows needed to service their debt. In addition, any early write-downs on underperforming investments can temporarily depress overall fund performance.

The value of the portfolio typically increases during the middle years of the fund's life as investments mature and interest income accumulates. The shape of the J-curve therefore depends largely on the quality of deal selection, capital deployment, and credit performance.

A flatter J-curve may indicate slower deployment, weaker investment performance, or delayed value creation, although it should always be assessed in the context of the fund's investment strategy rather than viewed in isolation.

Liquidity:

Private credit funds lack liquidity because of their long investment horizons and the bespoke nature of the underlying loans. Unlike publicly traded debt securities, these investments cannot usually be sold quickly without accepting a significant discount or waiting for a secondary buyer.

Accordingly, only investors who can remain invested until maturity should allocate capital to private credit funds. Depending on the fund documents and investor approvals, the asset manager may also extend the fund's tenure by one or more years to maximise recoveries or complete exits.

How can Private Credit be accessed in India?

In India, sophisticated high-net-worth investors can access private credit primarily through Category II Alternative Investment Funds (AIFs), which are regulated by the Securities and Exchange Board of India (SEBI) rather than the RBI. SEBI requires a minimum investment of ₹1 crore for most investors.

These funds typically have a tenure of four to eight years, depending on the investment strategy (such as real estate, structured credit, or special situations), with the possibility of an extension of up to two years, subject to investor approval and SEBI regulations.

The interest income or investment gains are taxed in accordance with the applicable tax treatment of the underlying fund structure and prevailing tax laws. Investors should seek professional tax advice based on their individual circumstances.

(Refer to our AIF taxation article)

How is a private credit fund different from a debt mutual fund?

What happens if a borrower defaults?

When AIFs provide private credit, they assess borrowers' risk profiles and impose financial covenants, monitoring mechanisms, and structured recovery processes to mitigate downside risk.

If a borrower defaults, the asset manager may seek to restructure the debt, enforce security, exercise contractual rights, negotiate with the borrower, or initiate legal recovery proceedings, depending on the circumstances and the loan documentation.

For AIF investors, defaults may result in lower fund returns, delayed distributions, write-downs, or partial loss of capital, depending on the severity of the default and the eventual recovery achieved.

The Ionic Wealth View

Looking at private credit as "high-yield FD" is not the right approach. It is a distinct, illiquid, credit-risk asset class that rewards diligence and punishes complacency.

The returns on private credit funds depend on selecting the right asset manager, whose underwriting discipline, portfolio construction, and recovery capabilities play a significant role in long-term investment outcomes.