Wall Street is divided over the rise of private credit

According to the proponents of private credit, there are several main differences between private credit funds and traditional banks:

1. Risk Management: Private credit funds argue that they manage risk better than traditional banks. They don't rely on short-term funding, which reduces the risk of a liquidity crisis. Instead, they lend money raised from large institutional investors such as pension funds and insurance companies that understand they won't get their money back for several years.

2. Regulatory Environment: Private credit funds operate outside the heavily regulated banking system, which gives them more flexibility in their lending practices. This flexibility can be an advantage when lending to midsize or below investment-grade borrowers in special situations like distress.

3. Asset-Liability Mismatch: Unlike some banks, private credit funds don't have an asset-liability mismatch. They don't face deposit runs and their loans are directly placed on the balance sheets of long-term investors like life insurance companies, which is a better match.

4. Performance: Private credit has brought higher investor returns than it has on average over the past decade. It has also outperformed a similar index measuring aggregate returns in private equity for the same period.

5. Flexibility: The terms of private credit loans are usually more flexible than what banks require, with adjustable interest rates, which can be an advantage or a dilemma for borrowers expecting interest rates to eventually drop4.

It's important to note that while private credit funds have their advantages, they also have their risks and are subject to less regulatory oversight than traditional banks.

Marc Rowan, CEO of Apollo, counters the argument that private credit increases systemic risk within the financial system by stating that private credit actually makes the system safer and more resilient34. He argues that every dollar that moves out of the banking industry and into the investment marketplace reduces systemic risk caused by the traditional banking industry.

Rowan explains that the typical bank is leveraged ten to twelve times, and moving money out of that system and into private investment platforms helps reduce systemic risk. He claims that this deleveraging process makes the system more resilient. Furthermore, he points out that governments around the world are encouraging banks to do less and investors to do more, which supports the growth of private credit.

In summary, Rowan believes that private credit, with its diverse funding sources, promotes resiliency in the US financial system and reduces overall systemic risk4.