OCC Rule Shift Raises Leveraged Lending Risk for Banks and Nonbanks

Nonbanks expanded sharply in corporate credit during the past decade, and this growth coincided with a market in which leverage steadily moved higher. Private credit funds and finance companies have became central players as banks faced new rules on leverage. New regulatory changes now set the stage for another shift.

Nonbanks Grew as Leverage Increased

Research from the Journal of Banking & Finance shows how the leveraged loan market evolved as nonbanks stepped in to fill the gap left by banks after 2013 supervisory guidance. The market grew to more than $1 trillion by 2018 (up from $400 billion in 2006) as borrowers carried higher debt loads and relied more heavily on lenders that used fewer covenants, longer maturities and collateral structures that reduced ongoing monitoring.

The research shows that borrowers using nonbank lenders engaged in more acquisition spending and asset expansion soon after loan origination. These behaviors, amplified by higher leverage, contributed to increases in firm level risk.

Regulators Withdraw Guidance, Reshape Rules

Late last week. the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation rescinded the 2013 leveraged lending guidance and the 2014 FAQs, calling them overly broad and overly restrictive. The agencies acknowledged that the previous framework pushed significant volumes of leveraged lending outside the banking system and contributed to the rise of nonbanks in a market where leverage had already been climbing. They noted that the guidance also captured loans that were never intended to fall under the definition of leveraged lending and constrained banks from applying standard risk management principles.

The withdrawal may give rise to a fundamental reset. Banks are now instructed to rely on general safe and sound lending principles. These include defining leveraged loans internally, establishing clear risk appetite frameworks, evaluating repayment capacity, monitoring borrowers through the life of the loan and applying consistent underwriting standards whether a bank originates or purchases credit exposures.

The rule change matters not only because banks can reenter the market, but because they are returning at a time when leverage has moved higher and borrower profiles remain risk sensitive.

More Competitive Market Meets Higher Leverage

Banks may now feel pressure to win back relationships that migrated to private credit funds during the past decade. The updated regulatory posture gives them more flexibility to compete, but it also brings new exposure. With leverage higher across many borrowers, even small shifts in underwriting leniency could generate broader system impact.

If banks attempt to claw back market share by easing terms to match nonbank pricing or structures, the system could absorb larger volumes of high leverage exposures. Because institutions can now tailor their own definitions of leveraged lending, variation across banks may increase, widening the range of acceptable leverage levels and repayment assumptions.

This creates an environment in which rules have changed while leverage has not reset. Instead, lenders are adjusting practices within a market that already reflects years of borrower debt accumulation.

PYMNTS Intelligence Shows Opportunity

The stage is set for more corporate demand for borrowing, particularly as the Fed lowers rates. PYMNTS Intelligence data from the Certainty Project finds that firms are operating with continued cost pressures, intermittent revenue visibility and uneven access to credit. In this environment, businesses value transparency, predictable repayment terms and responsive decisioning. These conditions present an opening for lenders that can offer speed without sacrificing discipline.

The new regulatory landscape does not eliminate risk. It shifts judgment to banks at a time when the underlying leverage of many borrowers (if they return to capital markets) remains elevated. Institutions will need to use cash flow analysis, forward looking risk scoring, covenant design and ongoing monitoring to ensure credit profiles align with risk appetites. Artificial intelligence can support this work by surfacing anomalies in borrower projections, identifying early signs of revenue stress and improving portfolio level surveillance.