Regional entities struggle with devising a defined strategy to address private credit risks, according to industry experts.
Banks are facing a new challenge in the form of the rapid growth of private credit and the encroachment by non-bank lenders. According to analysts, nonbanks operate with a lot more leverage than banks do, and designating a nonbank as systemically important could be a way to level the playing field.
The proposed rules by the Federal Reserve Bank of New York are expected to reveal more data and reporting around the dependency between the two sectors in the coming quarters. This increased transparency could help regulators like the OCC and US Treasury to introduce more transparency and stricter reporting requirements for private credit, reducing private lenders’ competitive advantage.
Banks are encouraged to engage in regulatory advocacy and compliance adjustments. By doing so, they aim to level the playing field by introducing more transparency and stricter reporting requirements for private credit, which could reduce private lenders’ competitive advantage and free bank capital for more lending. Regulatory proposals considering systemic risk-based leverage ratios aim to increase banks’ lending capacity.
Co-investment and partnerships are another key strategy banks are adopting. Instead of viewing private credit purely as competitors, many banks now co-invest with private credit funds or provide leverage to enhance returns, creating partnerships that reshape the lending landscape jointly rather than as adversaries.
Product and market differentiation is another strategy banks are employing. Banks selectively take on “trophy” or high-quality deals (investment grade, top-tier clients, infrastructure) leaving more complex or risky segments to private credit, thus maintaining strength in areas where regulation and capital structure favor them.
Flexible lending and multi-strategy approaches are also being adopted by banks and related funds. This allows them to flex between traditional cash flow lending and opportunistic strategies depending on market cycles, enabling them to compete dynamically with private credit in different environments.
Innovative lending structures are essential for banks to respond to the offerings of private credit firms, which excel by offering asset-based financing and other niche products. Banks must innovate in lending structures, including tailored solutions for private equity-owned companies and infrastructure.
Banks can also focus on middle-market companies that private credit is aggressively pursuing, combining relationship banking with competitive terms to retain and win borrowers. With increasing covenant-lite loans and potential credit deterioration in private credit, banks’ disciplined underwriting and restructuring capabilities can serve as a competitive advantage.
The battleground for lenders and nonbank firms seems to be the hearts and minds of large companies, which is considered a significant threat. Regional banks may not fully appreciate the opportunity size or the capability that exists in the nonbank space. Executives from JPMorgan Chase, Wells Fargo, and Regions Bank have all indicated that the role of private credit firms in the lending market has grown significantly.
Private credit firms have reached about $800 billion in assets under management, making direct lending a dominant focus. Some firms are preparing to be labeled as systemically important by the Financial Stability Oversight Council. The Federal Reserve Bank of New York has proposed new rules aimed at increasing the granularity of data revealing banks' exposure to nonbanks.
Bank lending has declined from 44% of all corporate borrowing in 2020 to 35% last year. The private credit market, including firms like Ares Management, Blackstone, and KKR, is increasingly involved in core middle-market lending, encroaching on banks' territory. It's still a very symbiotic relationship between banks and nonbanks, according to analysts.
The Fed's proposed rules are expected to reveal significant dependency between the two sectors, according to analysts. Banks' funding of nonbanks has skyrocketed, indicating a competitive relationship between the two sectors. Despite this, the relationship remains complex and evolving, with banks both competing and collaborating with private credit firms, supported by regulatory shifts aiming for a more balanced competitive environment. Banks’ success will hinge on regulatory engagement, capital and risk management agility, product innovation, and selective partnerships.
Banks are adopting strategic partnerships with private credit funds to reshape the lending landscape and compete effectively, rather than viewing these firms solely as competitors. The proposed rules by the Federal Reserve Bank of New York could increase transparency between banks and private credit, potentially leading to stricter reporting requirements for private credit, reducing their competitive advantage.
