Regulators Are Scrutinizing How Deeply Banks Are Tied to Private Credit

Regional banks have quietly expanded their exposure to private credit funds over the past few years, a relationship regulators are now scrutinizing after the sector’s rapid growth outpaced the oversight built for it.

Private credit funds, which lend directly to companies outside the traditional banking system, have grown into a multi-trillion-dollar industry over the past decade, filling a gap left as banks pulled back from certain types of corporate lending after the post-financial-crisis regulatory tightening. That growth has occurred largely outside the disclosure and oversight requirements that apply to regulated banks.

What’s drawn fresh regulatory attention is how intertwined the two systems have become. Banks increasingly lend to the private credit funds themselves, or hold stakes in them, creating exposure to a sector’s risks without the disclosure requirements that would apply if the bank had made the underlying loans directly.

Regulators are asking who actually bears the risk

Financial stability officials have flagged concerns that losses inside the private credit sector, if they were to occur at scale during a downturn, could transmit back into the regulated banking system through these lending and equity relationships — the kind of interconnected risk regulators spent years trying to reduce after the 2008 financial crisis.

“We moved risk outside the regulated perimeter. We didn’t necessarily move it outside the banking system’s exposure to it.”

Industry groups representing private credit funds argue their model has performed well through recent stress periods and shouldn’t be regulated as if it were a bank. Regulators, for their part, appear increasingly focused less on restricting the sector’s growth and more on simply gaining clearer visibility into exactly how exposed the traditional banking system has become.