- Key insight: Bank regulators say they are keenly focused on bank lending to private credit. While they do not see it as an immediate threat to financial stability, they say their understanding of how bank funds are being used in the space is lacking.
- Expert quote: "It's been very difficult for us to have a clear understanding of where those funds have been flowing." — Federal Reserve Vice Chair for Supervision Michelle Bowman
- Forward Look: Along with expanded data collection efforts around private credit, regulators are also open to taking fresh looks at the Community Reinvestment Act and bank merger analysis.
WASHINGTON — Private credit is an important part of the modern financial market, but its systemic risk footprint remains a mystery, the Federal Reserve's chief regulator told lawmakers on Thursday.
Bank lending to private credit and other nonbank financial institutions, or NBFIs, has been on the rise for years, Fed Vice Chair for Supervision Michelle Bowman told the House Committee on Financial Services, but it is unclear what exactly that lending is being used to fund.
"It's been very difficult for us to have a clear understanding of where those funds have been flowing," Bowman said. "Last month, we introduced a data collection to … understand exactly where those investments are going outside of the banking system into the NBFI space. That will allow us to better understand and see more transparently how bank funding is being used within the non-bank space, particularly private credit."
Bowman
Bank lending to nondepository financial institutions has grown at a compound annual growth rate of 21.9% since 2009, according to
Bowman highlighted the development in her prepared opening remarks.
"Non-bank financial institutions are capturing a growing share of the lending market, competing with or displacing traditional banks without facing comparable regulatory standards," Bowman said. "Additionally, though bank lending to this sector has grown rapidly in recent years, supervisory monitoring and Federal Reserve surveys show that banks have tightened lending standards for NBFIs based on concerns about underwriting and collateral quality."
Concerns about the sector have risen since a pair of
"We did see from some of the bankruptcies and challenges last fall with several private credit funds, that there were poor collateral management [practices], there was some fraud that was occurring, and then others, bankruptcies, and a lack of clear disclosures," Bowman testified.
Bowman said private credit has become a "very important service" that has arisen as the result of strict regulatory requirements imposed on the banking sector after the global financial crisis in 2008 and 2009. Higher risk-weighted capital requirements have made it difficult for banks to engage in certain activities directly, so instead they back private credit funds which are unbound by such restrictions.
Bowman said she hopes to bring some of those financing activities back into the banking system through the latest Basel III capital proposal. In the meantime, she said the private credit space is not an immediate concern for financial stability, but one that is worth exploring further.
"It's a very small proportion of the lending categories within the banking system, but it is something that we need to know more about, because it's very opaque," she said, "which is exactly why we're asking for more information from our regulated institutions."
Rep. Ritchie Torres, D-N.Y., pressed Bowman for her views on what the greatest potential risks were from the private credit sector.
"Do you think of it as a problem with liquidity, or is there evidence of a deeper problem with credit quality?" Torres said, adding concentration risks another potential vector of disruption.
"I think generally it's about underwriting quality," Bowman said. "If you're looking at a particular industry that may be more vulnerable to shocks or erosion of its previous positioning, then you should take that into account as you're trying to understand how you should structure a loan."
Bowman and the other regulators used the hearing to discuss their efforts to rollback what they viewed as overly burdensome regulatory requirements and unscrupulous supervisory practices, replacing them with "right-sized" standards and a focus on "material financial risks."
The nearly three-hour hearing provided Republicans on the committee to cheer on the regulatory and supervisory reforms being pursued by all four agencies that were represented. Democrats, meanwhile, used the hearing to lament rising prices and the deregulatory agenda under the Trump administration.
One heated exchange did break out between Gould and Rep. Maria Elvira Salazar, R-Fla., who took issue with a recent executive order from the Trump administration directing bank regulators to adjust anti-money-laundering enforcement to require more careful scrutiny of activity involving undocumented immigrant workers.
Salazar, whose district includes parts of downtown Miami and some of the city's southern suburbs, said the policy "could be damaging to the average American citizen," adding that, as Republicans, "we stand for less regulation, less paperwork, less hurdles to do business."
Gould responded by saying the order fits with long-standing compliance expectations for knowing banking customers.
"As a supervisor for the U.S. banking system, I expect it not to be used to facilitate illegal activities, whether it be financial fraud or money laundering, or anything of that nature," Gould said. "That is a long-standing obligation that we impose on banks, and I think it is an expectation that every American citizen has of its U.S. banking system."
Gould added that the OCC would provide banks clear guidance so they can comply with whatever policy change is implemented in response to the order.
"Banks have flexibility in the documentation that they use to establish the identities of their customers," Gould said. "I think it's probably appropriate to withhold judgment until we've actually done the work working with Secretary Bessent and the other federal bank agencies."
Other regulatory topics that arose during the hearing included the outlook for the Community Reinvestment Act and banker merger oversight.
The agencies are in the process of
Hill said the agencies will explore new ways to modernize the CRA once the 2023 rule is fully repealed.
"We have been evaluating a range of possible options for next steps, which includes both finalizing the proposal from last summer, but also considering other options for proactive reforms," Hill said. "That's something that we continue to consider and I think we are likely to decide on a path in the near future."
On mergers, both Bowman and Gould said they supported changes to the competitive market analysis process employed by the Department of Justice's Antitrust Division. The regulators noted that competition in the financial services industry has changed dramatically during the past three decades and now includes fintechs and other nonbank actors.
"It would be incredibly helpful for us to update that merger analysis, especially the competitive factors and the landscape of competition and how we weight each presence of different types of entities in that review," Bowman said.
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