For most of the twentieth century, a mid-sized company that needed a loan went to a bank. Increasingly, it goes to a fund. The borrower’s need has not changed; the identity of the lender has, along with the funding model, the regulatory treatment, and the location of the resulting credit risk.
Understanding why is more useful than knowing that it happened, because the reasons determine which parts of the shift are durable and which are cyclical.
Why the shift happened
Bank capital and supervisory requirements changed the economics. After the 2008 financial crisis, the Basel capital framework and its national implementations raised the capital banks must hold against risk, with leveraged lending among the more capital-intensive categories. Supervisory guidance on leveraged lending added constraints on the leverage levels regulated institutions would underwrite. None of this prohibited such lending, but it made holding certain loans more expensive for a bank than for an entity with no capital requirement and no deposit base.
Institutional capital sought yield. Insurers, pensions, and other long-horizon allocators looking for income found a floating-rate, senior secured asset with a yield premium attractive — and, importantly, had the long-duration liabilities to hold illiquid assets to maturity.
Private equity created steady, predictable demand. Sponsor-backed acquisitions need financing on deal timelines. A lender able to commit quickly, hold the entire facility, and close without syndication risk offers something a sponsor will pay for.
The intermediation model was proven. Once credit funds demonstrated they could originate, underwrite, and administer loans at scale, the constraint became capital rather than capability.
What each side actually offers
Neither is uniformly better; they compete on different attributes.
Banks bring cost and relationship. Deposit funding is generally the cheapest source of lending capital, so bank pricing is typically lower. Banks also provide the surrounding relationship — revolvers, treasury and cash management, foreign exchange, deposit services — that a term-loan fund does not.
Funds bring speed, certainty, and flexibility. A direct lender can often commit to a full facility and close on a defined timeline without syndication risk, which for a borrower in a competitive acquisition process can be worth more than a lower spread. Funds also underwrite structures banks may not: unitranche facilities collapsing senior and junior debt into one instrument, payment-in-kind features, and covenant packages tailored to a specific situation. And they will consider borrowers outside standard bank credit boxes — smaller, more leveraged, in transition, or in sectors banks have stepped back from.
The borrower pays for this. The persistent trade is a higher spread in exchange for speed, certainty, structural flexibility, and a single counterparty.
The relationship is not purely competitive
The framing of banks versus funds obscures how entangled the two have become.
Banks lend directly alongside funds, provide revolving facilities and working capital lines where a fund supplies term debt, and — significantly — lend to the credit funds themselves. Subscription lines, asset-based facilities, and leverage provided to funds and BDCs mean bank balance sheets retain exposure to this credit indirectly, at a different point in the structure and typically with more protection.
Some banks have formed partnerships or joint ventures with private credit managers, originating loans and distributing them to fund partners rather than holding them. The distinction between “bank lending” and “fund lending” is considerably blurrier in practice than the categories suggest.
Where the risk went
This is the substantive question, and it deserves to be stated precisely rather than characterized.
When a bank holds a loan, the credit risk sits on a deposit-funded, leveraged institution subject to capital requirements, ongoing supervision, and — in the U.S. — deposit insurance with a resolution regime. Losses hit bank capital, and severe losses can trigger public consequences.
When a fund holds the same loan, the risk sits with the fund’s investors: pensions, insurers, endowments, and increasingly individuals through semi-liquid vehicles. Losses reduce returns to those investors. There is no deposit insurance and no equivalent resolution regime, and generally no requirement to hold capital against the position beyond what the fund’s own leverage providers demand.
The optimistic reading is that this is a structural improvement. Credit risk has moved from leveraged institutions funded by demandable deposits into vehicles funded by long-term capital that cannot be run on. A drawdown fund holding loans to maturity cannot experience a depositor run and cannot be forced into fire sales the way a bank can. Losses are absorbed by investors who knowingly accepted the risk, which is what risk capital is for.
The cautious reading notes several things. Disclosure is thinner than for regulated banks, so aggregate exposures and quality are harder to observe. Bank lending to credit funds recreates linkages that the shift was supposed to sever, at one remove. Semi-liquid vehicles offering periodic redemptions to individual investors introduce a form of liquidity mismatch that the original institutional model did not have. And the sector has grown enormously without yet being tested through a full severe credit downturn at its current scale and composition.
Both readings are held by serious people, and the disagreement is not resolvable from the outside. What is fair to say is that the shift has redistributed credit risk to holders who are less leveraged and less run-prone, while reducing transparency and introducing new channels of connection that are not yet well understood. Anyone asserting confidently that it is unambiguously stabilizing or unambiguously dangerous is claiming more certainty than the evidence supports.
What it means for an investor
For an allocator, the useful implications are practical rather than macro:
- The yield premium has a source. It is compensation for illiquidity, for credit risk banks priced differently, and for the borrower’s willingness to pay for speed and certainty. Knowing which of these a given manager is actually harvesting is a real diligence question.
- Manager dispersion should be expected to be wide. In an asset class where the loans are privately negotiated and not marked by a market, underwriting quality is the dominant variable and it is not observable from returns until a downturn.
- Fund-level leverage matters to how the position behaves under stress, separately from the credit quality of the loans.
- The comparison that matters is not “fund versus bank” but what the manager is lending against, where it sits in the capital structure, and what its covenant package and workout capability look like.
The migration of lending from banks to funds is one of the more consequential structural changes in credit markets in decades. It is not a verdict on either lender type — it is a change in who holds the risk, and the eventual assessment will depend on how the sector performs in conditions it has not yet seen.
This guide is educational and general; it is not investment advice. Regulatory frameworks and market structure continue to evolve.
Frequently Asked Questions
Why did private credit grow at the expense of bank lending?
Several forces acted together: post-crisis bank capital and supervisory requirements made certain leveraged loans more expensive for banks to hold, institutional investors sought yield, and private equity created steady demand for acquisition financing that valued speed and certainty. Funds without deposit funding or bank capital requirements could hold loans banks found costly to keep.
What can a private credit fund offer that a bank cannot?
Typically speed and certainty of execution, a single lender relationship rather than a syndicate, willingness to underwrite the entire facility, flexible structures such as unitranche or payment-in-kind features, and comfort with borrowers or situations that fall outside bank credit boxes. Borrowers generally pay more for these.
Is private credit riskier than bank lending?
The loans are broadly similar in kind; what differs is who holds the risk and how it is funded. Banks fund with deposits and are subject to capital requirements and supervision. Credit funds fund with investor capital and, often, fund-level borrowing. Losses in a fund fall on its investors rather than on a deposit-insured institution—which is a different distribution of risk rather than automatically more or less of it.
Do banks still lend to these borrowers?
Yes, and the relationship is not purely competitive. Banks continue to lend directly, provide revolving credit and treasury services alongside fund-provided term debt, lend to credit funds themselves, and in some cases partner with them. Describing the two as strictly substitutes understates how interconnected they have become.
Does the shift create systemic risk?
It is genuinely debated. One view holds that moving credit risk out of deposit-funded, leveraged banks into long-term capital vehicles with no run risk makes the system more resilient. Another emphasizes reduced transparency, bank lending to credit funds recreating linkages, and the fact that the sector has not been tested through a full severe downturn at its current scale. Both arguments have serious proponents.
Sources
- Federal Reserve, Office of the Comptroller of the Currency, and FDIC Interagency Guidance on Leveraged Lending
- Basel Committee on Banking Supervision capital framework
- Investment Company Act of 1940, Section 54 et seq. (business development companies)
