Private Credit Surges as Banks' Funding Advantage Narrows, BIS Report

What's New: Private credit has exploded from just $0.2 billion in the early 2000s to over $2,500 billion today, with its growth bolstered by a narrowing cost-of-capital gap with traditional banks. According to BIS Quarterly Review's March 2025 analysis, business development companies' funding costs have converged with banks since 2010, eroding banks' historical advantage.

Why It Matters: As private credit expands into more industries, its growing footprint raises important questions about financial stability, credit access for riskier firms, and the evolution of financial intermediation. Understanding these drivers helps regulators anticipate shifts in lending landscapes and potential systemic risks.

Big Picture Drivers:

• Rates: Countries with lower policy rates show significantly larger private credit activity, with a 4 percentage point rate decrease associated with approximately 12% more private lending.

• Regulation: Post-crisis banking rules have pushed riskier borrowers toward non-bank lenders, with stricter bank capital requirements correlating with increased private credit presence.

• Efficiency: Banking sector efficiency has the largest impact on private credit growth, with less efficient banking systems creating space for alternative lenders to flourish.

• Leverage: Private credit funds, initially more equity-dependent than banks, have steadily increased their debt-to-equity ratios, helping narrow their funding cost disadvantage.

• Specialization: Individual funds remain highly concentrated in just a few industries (with concentration indices of 0.74-0.81), allowing them to develop expertise with specialized borrowers.

By The Numbers:

• Growth: Private credit AUM increased from $0.2 billion to $2,500+ billion in two decades

• Market share: The US accounts for 87% of global private credit volume

• Funding gap: The cost of capital spread between BDCs and banks narrowed by ~200 basis points since 2010

• Leverage shift: BDCs' debt-to-equity ratio increased from ~0.4 to over 1.0 since 2011

• Diversification: Private credit expanded beyond manufacturing/tech to cleantech and life sciences

Key Trends to Watch:

• Retail investors are increasingly targeted by private credit funds, raising questions about whether funds will need to diversify more and potentially dilute their specialized advantages.

• Open-ended structures are gaining popularity as fund managers experiment with vehicles allowing regular redemptions, potentially introducing new liquidity risks.

• Insurance companies have significantly increased their allocations to private credit, becoming major drivers of funding inflows.

• Cost of capital dynamics could shift as the era of low interest rates ends, potentially reversing private credit's funding advantage over banks.

The Wrap: Private credit's remarkable growth reflects both structural advantages in serving specialized borrowers and cyclical factors like low rates and regulatory change. The future relationship between banks and private credit will depend on whether funds can maintain their specialized edge while managing concentration risks as they attract more retail money and navigate a rising rate environment.