We show that business development companies (BDCs) – an important type of private credit fund – are very well capitalized according to bank capital frameworks. They have median risk- based capital ratios of about 36%, which is 26 percentage points more than the Federal Reserve’s stress testing framework would require. Our evidence thus cuts against the view that private credit has grown because nonbank financial intermediaries hold less capital than banks.

Instead, we argue that, for plausible parameters, banks find lending to private credit funds more attractive than direct middle-market lending. This is, in part, because over-collateralized loans to private credit funds get favorable capital treatment, enabling banks to exploit their low-cost funding.

We also present a model explaining banks’ observed preference for making middle-market loans via affiliated private credit funds rather on balance sheet. For plausible parameters, banks choose to forgo less expensive balance sheet funding to avoid the extra regulatory and supervisory costs of managing a risky loan portfolio on the bank’s balance sheet.

Finally, we examine the financial stability risks of private credit. While there is little risk to the solvency of private credit funds, they may deleverage during periods of stress. Our baseline estimates suggest that over eight quarters, the median BDC would reduce outstanding loan balances by 9.5%, about half by selling assets and half by using free cash flows to pay down debt rather than to make new loans.

We examine the interaction between private debt and bank debt in corporate borrowing.

Combining administrative bank loan-level data with private debt deals, we document

that many U.S. private debt borrowers also borrow from banks. When co-financing

these dual borrowers, private debt lenders provide larger, relatively junior, and riskier

term loans with higher spreads, while banks offer credit lines. After accessing private

debt, dual borrowers obtain additional bank credit line commitments, reflecting greater

demand for liquidity insurance and imposing drawdown risks on banks. Our findings

suggest that private debt substitutes for banks’ term loans while complementing their

liquidity provision through credit lines.

This paper examines the dual role of Business Development Companies (BDCs) as creditors and shareholders in the private direct lending market. Utilizing a comprehensive deal-level database, our analysis shows that dualholder BDCs are more effective monitors than sole lenders, benefiting from enhanced tools for information access and governance. This effectiveness allows them to charge higher loan spreads, while simultaneously reducing credit risk and lowering the borrowing cost of portfolio firms from other lenders. We rule out alternative explanations attributing higher loan spreads to mere compensation for capital injection or to hold-up by a dominant financier. Our findings highlight a critical mechanism through which BDCs serve a market segment — mid-sized firms with low (or even negative) cash flows and a lack of collateral but high growth potentials — that is typically undesired by traditional

bank lenders.