Private credit firms are facing a major test, with mom-and-pop investors pulling their cash in fear of corporate defaults spiking and artificial intelligence destroying many of the software businesses that these funds have lent to. After years of explosive growth, the industry has another challenge looming: A fightback from banks that’s being encouraged by US regulators.
Helping banks compete by loosening capital rules so they can go back to holding more kinds of debt on their balance sheets may make sense when it comes to safe mortgages, or loans to high-quality companies and projects. But any return to the days when ordinary depositors were directly exposed to highly indebted private-equity buyouts would be a bad move. US rule makers should cool their fever for deregulation. The UK plan to hunt out systemic vulnerabilities through a new kind of stress test is a much better way to improve transparency and protect the economy.
Comments from US watchdogs point firmly in the direction of taking the shackles off traditional Wall Street lenders so they can challenge alternative nonbank credit. Michelle Bowman, the Federal Reserve board member in charge of regulation, said banks should have the flexibility to compete. “Nonbank financial institutions continue to increase their share of the total lending market, creating strong competition for regulated banks without facing the same prudential standards,” she told the Senate banking committee on Thursday.
Her words matter now because the Fed is in the middle of redrawing its version of international capital rules that have already been adopted by other countries. The previous effort to write these rules under the previous Democrat administration was so poorly done it was dead even before Donald Trump won the 2024 election.
Treasury Secretary Scott Bessent set the tone under Trump last year. “The growth of private credit tells me that the regulated banking system has been too tightly constrained,” Bessent told Michael Milken on stage at the former financier’s conference.
Regulators globally have been becoming increasingly concerned about their ability to see and understand the risks in private markets even though the great shift that has taken place over the past 10-15 years happened by design. After the financial crisis of 2008, banking rules were overhauled to stop deposit-funded lenders betting on markets or directly lending to most high-risk borrowers.
The total money managed by private equity and private credit has mushroomed to more than $11 trillion from less than $3 trillion globally, according to the Bank of England. All nonbanks combined now hold more assets than all banks. One major concern is that this shadow banking sector, as it is known, has turbocharged its impact on the economy by borrowing from traditional lenders, too. In the US, bank loans to nonbanks have been the fastest-growing form of lending for years and hit nearly $2 trillion this month.
Jonathan Gould, the Trump-appointed head of the Office of the Comptroller of the Currency, an important US bank supervisor, has said this has left banks exposed to the same risks but with less control or ability to mitigate them. “Meanwhile, we as bank supervisors, have less visibility,” he told Politico in January.
Banks themselves mostly haven’t complained about the competition, focusing their lobbying on avoiding more increases in capital charges. But that has started to change under a rule-cutting White House. In January, Jamie Dimon, the outspoken chief executive officer of JPMorgan Chase & Co., plainly described the growing influence of private credit and insurers in lending as regulatory arbitrage. “One of the things I would tell the regulators is, when you see arbitrage, you should look at it and always ask the question: why?” he said on an earnings call. “There's nothing mystical about the loans that all these NBFIs (nonbanks) are making. It’s just bigger now.”
The Fed has already loosened some rules that will help banks lend more to hedge funds, trade more Treasuries and underwrite buyout loans at higher multiples of the borrowers’ profits. The question now is how much further US rulemakers will go. Their words send signals that would be worrying at any point in a market cycle — but are even more so now that the wheels are already threatening to come off.
A rush of private lending to highly valued software companies looks like turning sour with AI companies potentially upending their businesses. That’s prompted investors in a series of funds run by firms including Blue Owl Capital Inc. to head for the exits where they can. People have also been spooked by a handful of borrower blowups last year, including Tricolor Holdings and First Brands Group, where banks and private lenders were involved in funding these nonbank finance firms. Just this month, a UK-based complex-mortgage firm, Market Financial Solutions Ltd., has unraveled, leaving banks such as Barclays Plc and private firms including Atlas SP Partners again left picking through the mess to recover their money. The shortfall between the loans and the collateral could be as much as £930 million ($1.3 billion), Bloomberg News reported.
Some private-credit executives don’t expect significant rule changes. That might be down to hope as much as experience, but they are also right that moving riskier lending off bank balance sheets made them safer. The lending they now do instead to private credit funds ought to be better for depositors because the funds themselves will always suffer losses first, and the banks can seize underlying assets to sell if a fund runs into real trouble.
There is still a problem for the Fed and others, however, in understanding what a downturn in the economy and a jump in bad debts will look like in today’s world. We haven’t suffered a major recession since the 2008 meltdown — the economic mayhem of the Covid-19 pandemic was swiftly met with a flood of public money to keep everyone afloat.
This is where this year’s BOE stress testing comes in. With the help of all major banks and private asset managers, including Apollo Global Management Inc., Blackstone Inc. and KKR & Co., UK regulators are conducting an extended war game over several months to see how different players would respond in a major downturn. It is similar to the exercise it did with hedge funds in 2024. The test won’t answer all questions, but it will help policymakers get a better grasp of how such a shock would move through the financial system and hit the wider economy. It’ll also help supervisors work out what they don’t know, and where reporting and oversight should be beefed up.
An exercise like this would be even more valuable in the US, where nonbanks and capital markets play a bigger role in the economy. It’s definitely a smarter approach than slashing rules and finding out what happens. The world has seen time and again where that path leads — and it’s nowhere good.
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