Ampersand Explains: The Risks of Private Credit to Community Banks
When people talk about risks to the financial system, most point to student loans, regulatory actions from the CFPB, or inflation pressures. But one of the biggest emerging risks is getting far less attention: the rise of private credit.
Private credit funds are investment vehicles that are often backed by private equity firms, and these funds lend money outside of the traditional banking system. Unlike banks, these funds operate with little oversight and are not subject to the same capital, liquidity, or risk management requirements. That’s not to say they are without any oversight, but they certainly face less than US banks.
Why the growth of private credit matters
Banks, especially community banks, have seen their ability to take on lending risk steadily chipped away by regulation. The rules are designed to protect the financial system, but the unintended effect has been to push risky borrowers out of the banking system altogether. Private credit funds have stepped in to fill that gap.
These funds can lend quickly, often through fintech platforms that advertise “same day” loans. These platforms offer significant sums, with little paperwork and short notice. The speed and lack of oversight might look like innovation, but it creates two problems:
- Systemic risk – The risk isn’t gone; it’s just shifted to a less transparent part of the financial system. A wave of defaults in private credit could ripple through investors and markets in ways we can’t easily see or regulate.
- Pressure on community banks – Loan income is the lifeblood of community banks. If more lending moves to private credit funds, community banks are left with fewer opportunities to serve their local businesses and generate income.
The danger of consolidation
The long-term outcome of these trends is troubling. If community banks can’t compete, we risk repeating what happened in Canada, where just a handful of massive banks dominate the entire landscape. That would mean less choice, less access to credit for small businesses, and weaker local economies.
The irony is that regulators have “de-risked” the banking system so much that they may have created a different, more dangerous risk. Private credit is ballooning, fast, and it’s operating in the shadows. If the growth continues unchecked, it could undermine both community banking and the stability of the financial system.
At Ampersand, we believe strong, competitive community banks are essential to a healthy economy. That’s why it’s important to not only watch what’s happening in the banking space, but also to pay attention to what’s happening outside of it.
