This essay is based on the paper “Private Debt Versus Bank Debt in Corporate Borrowing” by Sharjil Haque, Simon Mayer, and Irina Stefanescu.
Over the past decade, private debt has emerged as an important source of financing in corporate borrowing in the United States, reaching levels comparable in size to the leveraged loan and high-yield bond markets. This extraordinary growth of private credit fills a critical gap in the market, offering flexible financing to companies that have reached their borrowing capacity with banks and cannot easily access public bond markets. Policymakers, among others, worry that private debt lenders are displacing traditional banks, shifting credit risk outside the regulatory perimeter.
Our research offers a more nuanced picture, where private debt does not replace bank debt but rather reshapes its role in corporate borrowing. Banks and private debt lenders increasingly co-finance the same borrowers, especially firms that are riskier, have fewer collateralizable assets, and operate mainly in technology-driven industries like software, healthcare services, and commercial services.
Dual Borrowers: The Intersection of Private and Bank Lending
We find that dual borrowers, that is, firms that simultaneously rely on both private and bank debt, account for more than half of all private debt borrowers in our data. These borrowers are generally larger than bank-only borrowers, have fewer collateralizable assets, carry a higher risk of default, and even have negative cash flows.
These characteristics help explain why they reach out for loans in both markets. Banks are often hesitant to extend large term loans to such firms, due to regulatory constraints or internal risk limits. Private debt lenders, in contrast, specialize in these higher-risk, longer-term loans. But banks still serve a vital purpose, providing liquidity to these borrowers through credit lines. Overall, private lenders handle the bulk of long-term financing for dual borrowers, while banks support firms’ day-to-day liquidity needs.
How Private Debt Shapes Banks’ Role in Corporate Credit Provision
We find that a borrower’s reliance on private debt is associated with greater reliance on bank credit lines. At first thought, this may not appear surprising since private debt lenders typically provide long-term loans (e.g., term loans), and it is well-known that borrowers often bundle term loans with credit lines. However, we find that a borrower’s propensity to obtain new credit lines after issuing private debt is substantially higher relative to a bank borrower that issued a new term loan. We even find that the new credit line amounts are larger relative to newly issued credit lines of bank borrowers, conditional on the bank borrower also obtaining a new term loan. In other words, our results go beyond the standard complementarity between credit lines and term loans and indicate that private debt uniquely amplifies credit line provision by banks. We find that these patterns are best explained by higher demand for credit lines from dual borrowers, who pay a higher price to obtain this additional liquidity. This could be because, for example, private debt lenders highly value the liquidity insurance from credit lines, and consequently encourage their portfolio companies to obtain credit lines from banks.
While this new financing model benefits firms by broadening access to capital, it also introduces new liquidity risks for banks. Private debt borrowers, being more leveraged and less resilient to shocks, are more likely to tap their credit lines during periods of stress. For example, in early 2020, dual borrowers drew down their credit lines far more than similar firms without private debt and saw sharper increases in default risk. Even if banks avoid the full credit exposure of risky term loans, they may still be at risk given the sudden, potentially large liquidity demands.
Complementing Banks’ Role, Not Replacing It
Rather than displacing banks, the rise of private debt appears to complement their role as liquidity providers. Banks are lending more, not less, to companies with private debt exposure, but the nature of that lending has shifted toward credit lines. This has important implications for how banks manage their own balance sheets, particularly their liquidity coverage and capital buffers. Our findings suggest that as more companies rely on private debt, banks become increasingly exposed to sudden spikes in liquidity demands. While this may not be an issue during normal times, it may pose significant challenges during market turmoil.
Policy and Investor Implications
Understanding the evolving dynamic between private debt and banks is important for investors, as the performance of private debt portfolios often depends indirectly on banks’ willingness to maintain credit lines. It is also important for banks as managing the liquidity risk of credit lines to leveraged borrowers becomes key for stress evaluation. It is also relevant for policymakers, as during stress periods, risks can migrate rapidly from the private debt sector to the banking sector via credit lines.
The New Normal in Corporate Borrowing
The private debt boom has transformed corporate borrowing. Rather than replacing banks, private lenders have redefined banks by shifting them toward offering liquidity support through credit lines. For borrowers, the emergence of private credit creates more growing opportunities. For banks, it requires sharper liquidity management. And for regulators, it introduces new forms of systemic exposure. The rise of private debt reflects the continued shift of financial markets from balance-sheet lending by banks to capital markets intermediation by debt funds. Still, in this new equilibrium, traditional banks remain indispensable.
Read the full paper here.
Irina Stefanescu is group manager in the Research and Statistics division at the Board of Governors of the Federal Reserve System.
This essay reflects the reviews of the authors and not of the Federal Reserve. It is part of the Financial Regulation Research Brief Series. Research briefs in this series highlight the policy-relevant research on financial systems, including the impact of financial regulations on economic growth and stability.
