Beyond the Banks: Private Credit and the Future of Lending

Even as private equity cools, the private credit market is rapidly growing, now valued conservatively at over $2 trillion. Private credit primarily takes the form of direct lending, where nonbank and other private institutions lend to companies. This boom is up by $400 billion since 2021 (while public debt has declined roughly the same amount in that period), and it is poised to grow another 87% in the next five years. The U.S. Securities and Exchange Commission (SEC) has concerns about the systemic risk associated with the private credit market’s opacity and is attempting to regulate it. But subjecting the private credit market to bank-style regulations is likely not the best solution.

Although private credit has existed for decades, its popularity has recently surged. Historically, businesses sought capital from banks and other highly regulated public institutions. The private lending industry arose after the 2008 recession when heightened banking regulations imposed tightened capital reserve, loan term, and disclosure requirements on public markets. In recent years, rising interest rates and inflexible loan structures in the public debt markets have led to untenable borrowing costs and stretched timelines for issuers seeking financing, resulting in a 25% dip in publicly traded high-yield debt in the last three years. In response, market share shifted from banks to the private sector as capital-hungry investors sought alternative borrowing options.

Private market heavyweights, such as Apollo and Blackstone, replicate traditional commercial banking practices but tap into deep pools of insurance capital to provide private loans rather than relying on highly regulated bank deposits. This liquidity enables them and other private credit firms to provide quick and adaptable financing solutions that are especially attractive amidst strapped, high-interest public debt markets. Corporate borrowers benefit from long-term financing structures and the relative freedom to bilaterally negotiate bespoke terms of size, type, or timing of transactions to meet borrowers’ and creditors’ distinctive needs—innovative agreement options that regulated banks cannot provide.

While regulators have yet to conclude that the private credit industry poses an immediate threat to the financial system’s stability, they have called for scrutiny. The SEC regulates private credit funds as private fund advisers, which are subject to limited disclosure requirements and often have greater discretion on investments. Critics—particularly from the banking sector—warn about the risks of private credit’s opacity and potential instability during economic downturns. Crucially, critics flag that the rapid growth of private credit and the resultant competition with banks to secure large transactions have led private credit providers to hastily deploy capital, leading to weaker underwriting standards, looser loan covenants, infrequent valuation, and unclear and often unassessable credit quality.

Perhaps most concerning is the muddled interconnectedness between private credit funds, commercial banks, and investors despite private credit’s lack of transparency. Increasingly, banks and private credit firms cooperate and compete. Although Deloitte found that many banks are not adopting new strategies in response to private credit, some heavy-hitters are. Where they cooperate, banks facilitate faster, more flexible lending terms for their corporate clients by serving as middlemen between private credit firms. Tapping into banks’ relationships benefits private credit firms and lowers credit risk for banks, although banks lose revenue. To compete directly with nonbanks, some banks, such as Morgan Stanley, are creating their own private credit capabilities.

Increased cooperation between banks and private funds has led regulators to scrutinize how banks, private equity firms, and insurers are tied to private credit, and how the private sector’s lack of transparency can affect those groups, creating wider systemic risk. The SEC recently called for greater transparency and regulation of private funds, and certain investors and investor groups have expressed support for wider availability of information related to fund performance and investment terms. However, a Fifth Circuit appeals court struck down a new set of proposed SEC rules that would require private fund advisers to provide investors with quarterly fee and performance reports, obtain annual fund audits, and prohibit certain preferential treatment of investors.

Increased transparency may prove beneficial in some regards, but private credit’s lack of transparency and regulation are what enable it to serve investors and companies so well. Saddling private credit with excessive regulation would defeat a crucial aspect of the sector’s strength. Considering that banks will continue to exist and not only compete with but support and benefit from the private credit market, the risks associated with prioritizing private decision-making—even if opaque—over regulatory decision-making are likely not fatal. As SEC Commissioner Hester M. Peirce illuminates, although “we should watch for hidden leverage, regulatory arbitrage, and hidden interconnections with banks,” we should not “run away from an efficient, effective, and economically useful form of finance.” Policymakers should aim to create a regulatory framework that enables private credit’s innovative financial solutions without excessive restrictions.