US banks ❤️ private capital

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Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.

Private capital firms and banks are sometimes cast as opponents, with the former ascendant thanks to all the regulatory burdens heaped upon the latter since 2008. In reality, they are in a torrid co-dependent relationship.

After all, private capital is in many cases utterly dependent on leverage to juice their returns to levels that can attract investors. At the same time, banks are thirsty for all the investment banking fees that private capital firms generate.

As result, the broader blob often referred to as “non-bank financial institutions” by regulators has in practice grown increasingly entangled with the traditional banking industry. But just how enmeshed are they?

Adam Josephson of the As the Consumer Turns newsletter has alerted us to an interesting new paper by two economists at the Boston Fed that attempts to answer that question.

Using regulatory data reported by large US banks, John Levin and Antoine Malfroy-Camine have attempted to assess the industry’s linkages to private equity and private credit firms specifically. FT Alphaville’s emphasis in the paper’s conclusion below:

We estimate the banks in our sample extend around $300 billion in loan commitments to PE and PC funds and other fund-level entities sponsored by those fund managers as of 2023. In total, these loan commitments represent about 14 percent of total loan commitments to NBFIs made by the largest U.S. banks (those subject to Federal Reserve stress tests), up from about 1 percent in 2013. As such, private funds may be growing more reliant on bank loans, both by taking larger loan commitments relative to fund assets and by utilizing a higher percentage of those loan commitments.

In absolute nominal terms, the amount of lending that big US banks have done to private capital firms has risen by about 30x, from about $10bn in 2013 to $300bn in 2023.

A few words on the ugly NBFI acronym. “Non-bank financial institutions” is an almost hopelessly broad term for everything that does financial services that isn’t a traditional bank. It’s become the preferred argot over “shadow banking” — given the latter’s somewhat insidious connotations — and encompasses everything from money market funds and insurers to hedge funds and infrastructure investing.

NBFI as a whole now accounts for about half the global financial system, according to the Financial Stability Board, and pretty much every regulator and financial watchdog on the planet has in recent years been warning about the dangers this poses.

Indeed, just last week the Federal Reserve announced that it was conducting an “exploratory analysis of risks to the banking system” as a complement to its standard supervisory stress tests. Here’s the brief:

This growth poses risks to banks, as certain NBFIs operate with high leverage and are dependent on funding from the banking…