In a dramatic shift on Wall Street, traditional banks are no longer the dominant players in corporate lending. Instead, hedge funds, private equity firms, and other alternative investment managers have stepped into the spotlight, fueling a surge in private credit. This trend, accelerated by high interest rates and regulatory changes, is transforming how businesses access capital—and raising questions about the stability of debt markets.

The Decline of Traditional Banks

For decades, banks like Credit Suisse and JPMorgan Chase were the go-to sources for corporate loans. However, the landscape began to change after the 2008 financial crisis, when stricter regulations forced banks to reduce risk-taking. The collapse of Credit Suisse in March 2023 and the failure of Silicon Valley Bank earlier that year further weakened the traditional banking sector. As banks pulled back, private credit funds stepped in to fill the void.

Private credit refers to loans provided by non-bank lenders, such as hedge funds and private equity firms, to businesses that may not qualify for traditional bank financing. These loans often come with higher interest rates and stricter terms, but for many companies, they are the only option. For example, Hyland Software, an Ohio-based business software company, turned to Golub Capital and other private lenders for a $3.4 billion loan after Credit Suisse’s collapse.

The Private Credit Boom

The private credit market has exploded in recent years, with assets under management growing from $726 billion in 2018 to $1.5 trillion in 2022, according to data provider Preqin. Firms like Apollo Global Management, Blackstone, and Ares Management have become major players, leveraging their expertise in private equity and distressed debt to expand into lending. These firms now control about $1 trillion in private credit assets, according to The Wall Street Journal.

Private credit funds are not just lending to midsize businesses; they are also financing massive deals previously reserved for banks. In August 2023, financial software maker Finastra borrowed $4.8 billion from Blue Owl Capital, Oak Hill Advisors, and others to refinance a loan arranged by Morgan Stanley—the largest private loan on record. Similarly, Magnetar Capital, a hedge fund, arranged a $2.3 billion loan for CoreWeave, a cloud-computing operator for artificial intelligence.

Why Private Credit Is Attractive

Private credit offers several advantages for both borrowers and lenders. For businesses, these loans provide quick access to capital, often with fewer regulatory hurdles than traditional bank loans. For investors, private credit delivers higher returns compared to other debt investments in a low-yield environment. Over the past decade, private lenders have delivered average returns of 9%, according to data provider Cliffwater.

The rise of private credit has also been fueled by the Federal Reserve’s higher-for-longer interest rate policy. As rates climbed to multiyear highs, banks became more cautious, while private lenders saw an opportunity to capitalize on the demand for alternative financing. Private credit funds are now expanding into new areas, such as asset-backed debt for real estate, consumer loans, and infrastructure projects.

Risks and Concerns

Despite its growth, the private credit market is not without risks. High interest rates have made corporate borrowers more likely to default, and some private lenders are concentrating their exposure by making larger loans to fund multibillion-dollar deals. Regulators are also concerned about the lack of transparency in the private credit market, which makes it difficult to monitor potential risks.

Moody’s Investors Service warned in a September 2023 report that the shift to private credit has concentrated economic activity in the hands of a small number of large, opaque asset managers. “Lack of visibility will make it difficult to see where risk bubbles may be building,” the report stated.

Investors, too, face risks. Private credit loans often come with tougher covenants, prohibiting borrowers from selling assets or raising new debt to generate cash. While these covenants may protect lenders in the long term, they also increase the likelihood of defaults in a high-rate environment. About half of the $190 billion in below-investment-grade bank loans coming due in 2024 and 2025 are rated B-minus or below, according to Moody’s.

The Role of Insurance Companies

One key driver of the private credit boom is the involvement of insurance companies. Firms like Apollo and KKR have built, purchased, or partnered with insurers to access hundreds of billions of dollars in capital. Much of this money must be invested in high-rated debt, prompting private credit funds to branch into asset-backed securities and other higher-rated instruments.

For example, Apollo financed a nearly $2 billion debt deal for music publisher Concord in December 2022. The loan is backed by royalties from songs by artists like Daft Punk, Little Richard, and Pink Floyd. Apollo also acquired Credit Suisse’s asset-backed business, further expanding its reach in the private credit market.

The Future of Private Credit

As private credit continues to grow, it is reshaping the financial landscape. Traditional banks are losing market share, while private lenders are gaining influence. This shift has implications for the broader economy, as more companies rely on expensive private loans to fund operations and growth.

Some analysts worry that the private credit market could become a source of systemic risk, particularly if defaults rise in a slowing economy. Others argue that private credit funds are better equipped to handle financial stress than banks, thanks to their stricter covenants and ability to intervene quickly in troubled loans.

Regardless of the outcome, one thing is clear: private credit is here to stay. As David Snyderman of Magnetar Capital put it, “There’s been a steady progression, but since Covid and the banking crisis this year, we’ve really seen the banks rein in risk.” In this new era of corporate lending, private credit funds are the new kings of Wall Street.

The rise of private credit represents a fundamental shift in how businesses access capital. While it offers opportunities for higher returns and greater flexibility, it also comes with significant risks. As regulators and investors grapple with these challenges, the private credit market will likely continue to evolve, shaping the future of corporate finance in ways we are only beginning to understand. Whether this trend leads to greater stability or new vulnerabilities remains to be seen, but one thing is certain: the days of bank-dominated lending are over.