By Telis Demos
An obscure bank capital rule has helped enable the growth of nonbank lending like private credit. It could be about to get even more enabling.
One of the goals of some newly proposed U.S. capital rules is to help foster more bank lending. The thinking goes that tougher capital requirements for banks since the aftermath of the 2008 crisis have helped give rise to more nonbank lending, including the now trillion-dollar-plus private-credit market. Within that market are the nontraded loan funds that have been receiving a lot of investor redemption requests.
But some of the changes could also incentivize banks to lend still more money to nonbank lenders. And it should challenge the idea that banks and private-capital managers are playing a zero-sum game with each other.
That is because some bank lending to other lenders can also potentially be treated by the capital rules like a securitization. Though securitizations of private loans aren't necessarily sold off to investors, like a familiar package of mortgage or auto loans, they can feature some key similarities.
The bank will lend against a special entity holding loans as collateral, and it will lend out only a portion of the underlying collateral's value, for example. With this cushioning, along with other features, such lending can be viewed under the capital rules as the bank having a more senior "tranche" of exposure, making the treatment for this lending less risky than the underlying loans themselves would be.
Under the existing rules, the lowest risk weighting a bank's securitization exposure qualifying for this treatment could get is 20%. The recent proposal by the Federal Reserve and other agencies now under consideration would lower that floor to 15%.
These risk weightings aren't set in stone and can rise under various circumstances, including if more of the underlying loans become delinquent. These rules fall under what is currently called the simplified supervisory formula approach, or SSFA.
When it comes to the types of loans private-credit funds make, if a bank made the underlying loans themselves and held them on their books, they might receive risk weightings of 100% or more.
So the upshot for a bank is that lending to a financial intermediary that makes certain loans, even at a lower yield, can be much more profitable than making those loans itself. This can be due to the capital treatment, and things like potentially lower loss rates and lower costs of dealing with one client rather than dozens.
In a paper by researchers Sergey Chernenko, Robert Ialenti and David Scharfstein, the authors estimated that considering factors like that, a typical loan to a middle-market company might be expected to generate a roughly 13% return on equity for a bank, versus a potential 24% return for a typical private-credit fund loan.
"The economics of lending to the lender is better from a bank's perspective than lending to riskier credits," said Scharfstein, a finance professor at Harvard Business School.
Some banking groups have argued that these structures do a good job protecting banks from losses, and that the current rules have over time discouraged the securitization of some loans, possibly raising borrowing costs in the economy. In the proposal, the 15% floor, and several other tweaks, would update the existing SSFA with a new framework.
Whether or not banks take more risk by applying the same structure to the kinds of loans made by funds like business-development companies, which often lend to midsize companies owned by private-equity firms, is difficult to say. That requires knowing more not only about the underlying loans, but also how much loss cushion the banks have given themselves and other terms of the arrangements.
But this dynamic of banks getting favorable capital treatment for lending to lenders has helped turn banks and private lenders from potential rivals into something more like frenemies. Loans to nondepository financial institutions now make up about 14% of total bank lending in the U.S., according to Fed data.
It isn't clear how much lending to private-credit funds, specifically, qualifies for lower-risk-weighting treatment. But overall, insured banks in the U.S. had about $925 billion of potentially qualifying on-balance sheet securitization exposures, excluding what they held in their investment portfolios and trading books, according to regulatory reports compiled by banking data and software provider BankviewUSA.com. That translated into just under $210 billion of risk-weighted assets, or about 23% of the exposure, under the SSFA standard.
The regulators' broader capital proposals are sprawling, across more than 1,000 pages. These proposals will also receive comment and might be revised before being adopted. There are other proposed changes that give banks more favorable treatment of their own loans, in areas such as mortgages. So when all of that is considered, the incentives baked into the proposals may move the needle more toward banks holding loans directly.
But with private credit and its risks in the spotlight, the treatment of bank loans to other lenders should get much more attention than usual.
Write to Telis Demos at Telis.Demos@wsj.com
(END) Dow Jones Newswires
March 25, 2026 05:30 ET (09:30 GMT)
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