When a family-owned packaging company needed to replace two ageing machines this autumn, its bank offered a five-year loan at a rate the owner described as "possible, but painful". A private credit fund offered the same money in eleven days at a higher rate, with a covenant tied to monthly revenue.
The company took the private loan. It is one of a growing number of small and mid-sized firms doing so, not because bank credit has disappeared, but because the terms have changed.
Key facts
- Bank lending to small firms has grown more slowly than nominal GDP for five consecutive quarters.
- Private credit funds now hold a record share of mid-market lending in several European markets.
- Average spreads on small-business loans are 120 to 180 basis points wider than in 2021.
- Asset-based lending, secured on inventory or receivables, is the fastest-growing segment.
- One in five small firms surveyed says it would fail a stricter refinancing test.
- Defaults remain low, but recovery rates on unsecured loans have fallen.
Why banks pulled back
The retreat is partly cyclical and partly structural. Higher rates have raised the cost of capital for banks, while stricter rules on capital adequacy make small-business loans less attractive than mortgages or sovereign debt. Branch closures have also eroded the local relationships that once substituted for hard collateral.
None of this means banks have stopped lending. It means they have become more selective, and the firms that fall outside the criteria have to look elsewhere.
The private credit option
Private credit funds pool money from pension funds, insurers and wealthy individuals and lend directly to companies. They typically charge more than banks, but they can move faster and are more willing to structure a deal around a borrower's cash flow.
That flexibility cuts both ways. Covenants are often tighter, and a missed monthly threshold can trigger a fee or a demand for extra collateral. Borrowers who do not read the fine print can find themselves with less room than they had before.
"The money is there. What has changed is who is willing to take the risk, and what they want in return."Adviser to mid-market borrowers
The rise of asset-based lending
The fastest-growing product is not a general-purpose loan but a facility secured on specific assets. A retailer can borrow against inventory. A haulier can borrow against invoices. A manufacturer can borrow against equipment.
Asset-based lending is older than the current cycle, but it has become more important as banks tighten. It is also more transparent in one respect: the lender can see exactly what backs the loan, which often means a lower rate than an unsecured facility.
The cost of the shift
The immediate cost is interest. A firm that borrowed at 4% in 2021 may now pay 8% or more, depending on its sector and collateral. For a business with thin margins, that difference can absorb most of its profit.
The second cost is flexibility. Bank loans often come with relationship managers who can renegotiate a covenant after a bad quarter. Private credit funds are more likely to enforce the contract.
The third cost is systemic and harder to see. Lending that moves outside the banking system is less visible to regulators, and the risks are concentrated in funds that may face redemption pressure in a downturn.
What regulators are watching
Supervisors have begun asking insurers and pension funds for more detail on their private credit exposure. The concern is not that the asset class is unsafe in isolation, but that its growth has been rapid and its valuations are based on models rather than traded prices.
The Financial Stability Board and the OECD have both flagged the opacity of non-bank lending as a gap in the post-2008 framework. So far, the warning has not translated into new rules.
What firms should do
Advisers offer a short list. Compare the all-in cost, not just the headline rate. Read the covenants and model what happens if revenue falls by 15%. Ask whether the lender has a history of working through difficult quarters. And keep a banking relationship alive even if the current loan comes from elsewhere.
For the packaging company, the private loan worked. The machines are installed, orders are up, and the monthly covenant has been met. But the owner is already thinking about refinancing once rates fall, which is exactly the behaviour that worries regulators. The longer the pause in rates lasts, the more firms will be making the same calculation.
