Private credit: the new force in corporate lending?

Answer

Summary: Following the 2008-2009 financial crisis, tougher banking regulations helped drive corporate lending away from banks and towards private credit providers. While private credit offers borrowers greater flexibility and faster access to finance, regulators are increasingly concerned about risks posed by this growing “shadow banking” sector and banks' exposure to non-bank lenders. This article explores the regulatory, commercial and financial factors behind this shift, and examines whether proposed reforms can restore a balance between banks and private credit.

One of the most pronounced trends in banking and commercial lending markets in the United States since the financial crisis of 2008-2009 has been the rapid growth of private credit and its expansion into corporate lending, which had previously been dominated by commercial banks. This related trend has been due to the increased exposure of banks to private credit lenders and non-depository financial institutions (NDFIs) generally, as banks have to a substantial extent substituted lending to credit market intermediaries for direct lending to corporate borrowers.

As discussed in this article, the partial withdrawal by banks from at least some types of corporate lending has been driven in part by certain prudential regulatory measures applicable to the US banking industry that were put in place following the financial crisis in an attempt to prevent a recurrence of that crisis and to address perceived risks to US financial stability. However, the shift of corporate lending from banks to unregulated NDFI intermediaries (referred to by some commentators as the "shadow banking system") was most likely not the result that had been intended.

That shift of corporate lending from the regulated banking sector – where loan quality, underwriting standards and mitigation of default risk are the subject of regular and comprehensive examinations by federal and state bank regulatory agencies – to private credit lenders who are not subject to prudential regulation, and the replacement by banks that are certain of their direct lending to corporate borrowers with the provision of credit lines and other funding to private credit lenders and other NDFIs, has become a source of increasing concern for US federal bank regulatory agencies. In particular, Governor Michelle Bowman, Vice Chair for Supervision of the Board of Governors of the Federal Reserve System (Federal Reserve), has noted that, "the growth of lending in the shadow banking system can have significant consequences for the availability of credit over economic cycles, with losses eventually being transferred to regulated depository institutions, as appears to have occurred after the 2008 financial crisis," and that when lending activities are pushed out of the regulated banking system, "losses may be transmitted back into the banking system through related activities like the extension of credit by banks to those same nonbank lenders."

This article examines some of the key drivers for these trends and also discusses how the US federal bank regulatory agencies are responding to the alleged risks posed by these shifts to US banking markets and US financial stability.

Regulatory drivers of the migration of corporate lending from banks to private credit

Federal Reserve Governor Bowman has observed that:

• When regulatory requirements become disproportionately burdensome relative to risk and banks simply curtail the targeted activities. . . [t]his leaves a deficit between demand for banking services and banks that are willing to provide them. When banks are no longer willing to provide specific services, non-banks step in to meet those needs, and the activity is essentially pushed out of the regulated banking system; and
• This includes the migration of corporate lending from banks to non-banks.

Although there are a wide variety of ways in which the conduct of bank activities is subject to regulatory requirements and restrictions that aren’t applicable to NDFIs conducting the same types of activities, it’s generally understood that the regulatory capital requirements for US banks and their holding companies and the Leveraged Lending Guidance issued by the US federal bank regulatory agencies in 2013, have had a disproportionate impact on the migration of corporate lending from banks to private credit, particularly for lending to borrowers with higher levels of leverage.

Regulatory capital requirements

Federal Reserve Governor Bowman has observed that:

• There’s no mystery about what drove the shift in corporate lending away from banks. While post-2008 financial crisis reforms strengthened bank capital and liquidity – which were necessary to promote the safety and soundness of banks and US financial stability – they did so with unintended consequences. Attempts to address legitimate gaps resulted in some requirements becoming excessive relative to underlying risk, forcing banks to pare back on some corporate lending activities or to raise the cost of credit to borrowers; and
• The effects of the current framework become clear when we examine the incentive structure that it creates. Current capital rules create a perverse incentive – ironically, banks receive a more favourable treatment for lending to private credit funds than for lending directly to creditworthy corporations. This treatment encourages banks to finance intermediaries rather than directly serving end-borrowers.

Specifically, under the standardised approach in the US bank regulatory capital regulations that are currently in effect, the generally applicable risk weighting for most types of corporate exposures is 100% of the amount of the exposure. There’s generally no reduction in risk weighting for a loan by a bank to a corporate borrower based upon the borrower's credit rating.

In contrast, a bank loan to a private credit fund or a BDC can at least in some cases be structured as a securitisation exposure under the regulatory capital regulations. The "simplified supervisory formula approach" in those regulations for assigning risk weightings to securitisation exposures generally provides for a risk weight floor of 20% of the amount of the exposure.

As a result, bank lending to private credit funds and BDCs can require substantially less regulatory capital for the lending bank than would be required for a loan by the bank directly to the corporate entity that’s borrowing from the private credit fund or BDC.

Leveraged lending guidance

The Leveraged Lending Guidance and the FAQs were adopted in the period following the 2008-2009 financial crisis when Congress and the federal bank regulatory agencies were imposing increasingly stringent restrictions and requirements on the US banking industry in an attempt to prevent a recurrence of the crisis. Which, in the view of many commentators, resulted in large part from loose lending standards by banks and other lenders, and to limit the perceived risks to US financial stability.

The Leveraged Lending Guidance and the FAQs were prescriptive in nature, containing some quite specific regulatory expectations for banks' leveraged lending activities, which were sometimes regarded by the banking industry as "bright line" tests. In particular, with regard to bank underwriting standards for leveraged loans, the Leveraged Lending Guidance stated that "a leverage level after planned asset sales (ie, the amount of debt that must be serviced from operating cash flow) in excess of 6X Total Debt/EBITDA raises concerns for most industries."

A bank that originated a leveraged loan, rated as a non-pass at inception because the loan didn’t meet those standards or the other limitations and requirements in the Leveraged Lending Guidance and the FAQs, risked examiner criticism and potentially an examination ratings downgrade for engaging in unsafe and unsound lending practices, even where the loan was originated by the bank solely for distribution rather than for the bank's own loan portfolio.

The OCC and the FDIC announced in December 2025 that those agencies were formally withdrawing from the Leveraged Lending Guidance and the related FAQs. In their Interagency Statement on that withdrawal, the OCC and the FDIC stated that the Leveraged Lending Guidance and the FAQs were:

• "Overly restrictive and impeded banks' application to leveraged lending of the risk management principles that guide their other business decisions. This resulted in a significant drop in leveraged lending market share by regulated banks and significant growth in leveraged lending market share by non-banks, pushing this type of lending outside of the regulatory perimeter."

Although the Federal Reserve hasn’t yet announced whether it will also be formally withdrawing from the Leveraged Lending Guidance, a Federal Reserve staff publication has noted that the Leveraged Lending Guidance "likely contributed to the post-[Great Financial Crisis] decrease in the market share of corporate loans held by banks, especially in the riskiest segment of corporate lending." FDIC staff publications have also noted that "NDFIs, particularly those typically known as ‘private credit funds’, have stepped in to supply this market." Leverage levels in excess of those prescribed by the Leveraged Lending Guidance are now seen with some frequency in corporate lending by private credit funds, BDCs and other NDFIs.

Business and financial drivers of migration of corporate lending to private credit

In addition to the regulatory drivers for the migration of corporate lending from banks to private credit funds, BDCs and other NDFI lenders, there are a number of business, structural and financial factors that have contributed to that trend. Federal Reserve Governor Bowman has observed that:

• NDFIs serve legitimate functions through their specialisation in narrow market segments, speed of origination and flexibility in credit terms. They’re well-suited to provide long-term loans to borrowers that may be unsuitable for banks – typically, smaller and riskier borrowers – financed with locked-in capital from institutional investors. BDCs, for instance, make most of their loans at spreads of 400 basis points or more, whereas large banks make most of their loans at 200 basis points or less.

A Federal Reserve staff publication has also observed that the growth of private equity is also responsible for the growth of private credit, as private equity typically needs debt financing for buyouts and acquisitions and private credit lenders are often better suited to provide – and increasingly do provide – that type of financing compared to syndicated bank lending. That publication also noted that "the growth of private credit is also driven by its relative attractiveness to borrowers and investors."

• Borrowers and their private equity sponsors might prefer [the] private credit market over public credit markets due to easier and faster origination processes as private credit deals don’t require syndication or ratings, hence no sharing of company financials with a large group of potential lenders. Also, as there’s no syndication of a private credit loan following its origination, the pricing of the loan doesn’t allow for market flex terms, which lead to uncertainty regarding the final pricing of loans issued in the leverage loan market. Although private credit loan contracts tend to be more covenant-heavy than their public counterparts, higher creditor control brings the benefit of being able to provide more customised loan terms. For instance, private credit loan contracts might include payment-in-kind clauses which enable a borrower to defer its interest payments and add them into the principal if the borrower faces challenges during the loan lifespan. Delayed-draw term loan features also provide much needed financial flexibility to borrowers, as most of these borrowers are private equity buyouts and need financing along the way for future growth opportunities, such as new acquisitions. Furthermore, having a post-origination renegotiation when a company faces challenges is much easier under a private credit loan contract as it involves only a single lender or a few.

As noted above, the ability of private credit funds, BDCs and other NDFI lenders to lend to borrowers with higher levels of leverage than would be possible for a syndicate of bank lenders – even following the withdrawal by the OCC and the FDIC from the Leveraged Lending Guidance – is also a major factor for the growth of buyout and acquisition financing by non-bank lenders.

Additionally, private credit funds and similar non-bank lenders benefitted from, and grew dramatically as a result of, an influx of capital into alternative investments by investors seeking higher yields during the low-interest rate environment that prevailed in the years following the 2008-2009 financial crisis through the covid-19 pandemic.

Regulatory response to partial retreat of banks from corporate lending and increasing exposure of banks to non-bank lenders

As noted above, the OCC and FDIC have formally withdrawn from the Leveraged Lending Guidance and the FAQs, explaining that the guidance was "overly restrictive" for bank lending and responsible for pushing leveraged lending outside of the regulated bank market. Although the Federal Reserve hasn’t taken any comparable action at this point, for the reasons discussed in our Client Alert on the OCC and FDIC action it seems doubtful that the Federal Reserve and its bank examiners are now treating the Leveraged Lending Guidance – to the extent that they are continuing to apply that guidance – as anything other than non-binding supervisory guidance on the risks posed to banks by leveraged lending transactions.

As a result, banks should have somewhat more flexibility as a regulatory matter to extend loans with leverage levels or other features than would have been possible had the Leveraged Lending Guidance remained fully in effect, although the extent to which banks will be in a position to recapture at least some of that lending business from the non-bank lenders that have come to dominate in that specific sector of the credit markets remains unclear.

Additionally, Federal Reserve Governor Bowman, in her May 2026 speech, has identified the steps that the Federal Reserve – in conjunction with the other federal bank regulatory authorities – is taking to address the alleged risks posed by the growth of the "shadow banking system" that’s resulted from the migration of corporate lending from banks to private credit and other non-bank lenders and the substitution by banks of their direct lending to corporate borrowers with the provision of credit lines and other funding to private credit funds and other non-bank lenders.

The primary step being taken by the Federal Reserve, in conjunction with the OCC and the FDIC, has been the March 2026 proposal for the updating of the agencies' Basel III regulatory capital regulations, which if adopted in final form would reduce the risk weightings for certain types of corporate loans and other bank loans, among other proposed changes. In particular, the proposal would:

• Replace the Internal Models approach and the standardised approach that the largest US banking organisations have been required to use to determine credit risk weightings with a new "expanded risk-based approach," which would provide for standardised credit risk weightings for various categories of exposures that reflect more granular risk measures such as the assessed creditworthiness of corporate borrowers, loan-to-value ratios for residential mortgages and other real estate exposures, and repayment history for retail exposures. Under that proposed approach, a bank exposure to a corporate obligor that’s investment grade (based on the banking organisation's internal ratings system) would be subject to a 65% minimum risk-weighting compared to the 100% risk weighting that currently applies under the regulatory capital rules to corporate exposures generally; and
• Update the standardised approach that generally applies to smaller US banking organisations as well as to the largest banking organisations in order to incorporate more granular measures of credit risk that are particularly material to bank lending, such as those noted above for the expanded risk-based approach. The proposals would also reduce the standardised risk weight applicable to corporate exposures generally from 100% to 95% and the risk weight applicable to all assets not specifically assigned a different risk weight under the rule from 100% to 90%.

As explained by Federal Reserve Governor Bowman in her May 2026 speech, these changes are intended to reduce the gap in risk weights between bank loans to non-financial businesses and bank loans to NDFIs. However, given that (as noted above) private credit loans are often either unrated or rated below investment grade and typically involve borrowers with higher levels of leverage compared to borrowers from banks, it’s unclear to what extent the changes to the risk weightings that are being proposed would slow or reverse the migration of corporate lending from banks to private credit, at least for lending to sub-investment grade borrowers.

Governor Bowman noted in her May 2026 speech that the proposed changes in risk weightings for bank loans aren’t intended by the federal bank regulatory agencies to eliminate private credit from the market, but rather are intended to address the situation where creditworthy businesses that could be served by banks instead turn to private credit primarily because of excessive regulatory burden for bank lenders. She observed that there’s a role for both banks and NDFIs in providing credit to private companies given that some lending by NDFIs is riskier and better kept outside of regulated financial institutions, and that "the optimal outcome preserves this division of credit provision. Private credit funds and banks can effectively serve different parts of the market."

Governor Bowman also announced in the May 2026 speech that the Federal Reserve is seeking to update certain regulatory reporting requirements for banks in order to obtain more information on bank lending to NDFIs, so that the Federal Reserve can better measure and monitor the types of risk posed to the banking system by such lending.

• Our current data reporting relies on industry classification codes that are too broad to effectively measure these specific exposures.
• The current industry code for «Other Financial Vehicles» includes hedge funds, private equity funds, private credit funds, BDCs, special purpose entities, and asset-backed security issuers – without further distinction. This lack of granularity makes it difficult to assess concentration risks, measure interconnectedness or calibrate capital requirements to actual risk.
• Therefore, the [Federal Reserve] Board will update our regulatory reporting to ensure that supervisors have transparency into bank lending to NDFIs. The update requires the largest banks to report financial information about NDFIs to which they extend credit, including total assets, net income, and leverage that enable an analysis of credit underwriting and ongoing risk assessments.

Conclusion

It remains to be seen whether the planned regulatory response to the migration of corporate lending from banks to private credit and the concomitant increase in banks' exposure to NDFIs will be sufficient to slow or reverse those trends, which are now fairly deeply entrenched. That’s particularly so in light of the fact that those changes resulted in substantial part from business and financial factors independent of the incentives (or disincentives) for bank lending created by the regulatory approach adopted by the federal bank regulatory agencies and Congress following the 2008-2009 financial crisis. Additionally, it’s possible that as a result of a change in US administrations following the 2028 election there will be changes in the leadership of the federal bank regulatory agencies and in the approach taken by those agencies in responding to these trends.

Jiang Liu and Glen R. Cuccinello are members of the financial services regulatory group in White & Case LLP’s New York office.