Loan commitments from large banks to private equity and private credit funds are increasing rapidly. A new note from the Federal Reserve Bank of Boston estimates that these loan commitments grew from about $10 billion in 2013 to about $300 billion in 2023 – nearly 30 times larger.

The authors write that it’s critical to understand the scale and complexity of lending relationships between banks and non-bank financial institutions, or NBFIs – including private equity and private credit funds. That’s because regulators need insight into these connections to better monitor potential risks to banks and the broader financial system.

Lending relationships between banks and private funds can be “opaque” because public disclosures in these industries are limited, said note co-author John Levin, a senior markets specialist in the Boston Fed’s Supervision, Regulation & Credit department.

“We use regulatory data from large banks to examine these lending relationships,” he said. “We found through our analysis that they are growing and warrant continued monitoring.”

Private funds: bank competitors, or big borrowers?

Levin co-authored the Supervisory Research and Analysis note, called “Bank Lending to Private Equity and Private Credit Funds: Insights from Regulatory Data,” with Boston Fed senior risk analyst Antoine Malfroy-Camine.

Private equity funds typically invest in private companies, meaning those not listed on the stock exchange. They usually aim to increase the value of a company and then sell it for profit. Private credit funds use investor capital to provide loans to private companies. They do not have to comply with the traditional regulatory requirements that banks must follow.

Levin said there’s a common narrative that banks are losing potential borrowers to non-bank financial institutions like private funds. But the Boston Fed note shows that these funds are also borrowing from large banks.

To estimate the extent of bank lending to these funds, the authors analyzed data provided by 31 large banks with more than $100 billion in assets which were subject to the Federal Reserve’s 2024 stress tests. That included details of more than 50,000 “fund-level” loan commitments made to private funds.

The authors said they focused on these loan commitments because this data helps provide a more representative estimate of the total loan exposure that a bank could potentially face. A “loan commitment” represents the maximum amount of money that a bank has committed to loaning a private fund. But in practice, the fund may only be using a portion of the overall loan maximum, the researchers noted.

For instance, a person might have a $10,000 limit on their credit card, but they can choose to only spend a portion of that limit – say, $1,000, or 10% – at any given time. While the actual lending mechanisms are quite different, this simplified example helps illustrate how private funds borrow from banks, Malfroy-Camine said.

Authors trace “opaque” bank connections back to private fund owners

The authors found that fund-level loans to private equity and private credit made up about 14%, or $300 billion, of large banks’ total loan commitments to non-bank financial institutions in 2023 – up from about 1% in 2013. Lending to NBFIs accounted for about 10% of total lending by large banks in 2023, a small but growing fraction of that business.

The authors had to do additional research to figure out how the borrowers listed in the data traced back to larger private fund management companies, or “sponsors.”

For example, Levin said the data might show a loan commitment from a bank to ABC Funding Corp. But further digging through regulatory filings, news articles, and other documents might reveal that ABC Funding Corp. is part of another larger private equity fund. Then, additional research might show that this fund is owned by an even larger company that manages many different private funds.

By mapping individual loans to the management firms that are ultimately taking them out, the authors can gather insight into how concentrated these loans are, which is useful for potential risk monitoring: Are the private funds that take out the bank loans run by many different firms? Or are a handful of firms responsible for the many different funds that banks are lending to?

They found that five companies are the recipients of about $100 billion, or one-third, of the loan commitments that large banks have to private funds. Still, that doesn’t mean the lending risks are as concentrated as it might appear. The authors note that even if one private fund management company has billions in loans, each loan has its own individual repayment terms and collateral. That lowers the potential default risks banks face when providing lines of credit to such a company.

“Our study illustrates the increasing connections between banks and non-banks,” Malfroy-Camine said. He added that more information on these connections can be found in the Federal Reserve’s recent Financial Stability Report.

Read the full note on bostonfed.org.