Financial regulations resulting from the Great Financial Crisis, including Basel III, The Dodd-Frank Wall Street Reform, and the Consumer Protection Act (2010) have attempted to ensure that banks are well-capitalized to avoid future taxpayer bailouts of banks. As a result, banks are subject to annual stress testing, which has caused them to increase their holdings of assets that are of higher quality and reduce riskier assets and activities. The shift has resulted in banks restricting their lending to riskier borrowers. Given that middle-market firms are typically considered riskier than larger more well-capitalized companies, banks lending to middle-market lending companies have contracted.
These regulatory changes have impaired access to financing for middle-market firms to a greater degree than small or larger firms. Small firms typically access credit through smaller regional bank loans, credit cards, and bank lines of credit. Larger corporations can access both public and private markets for equity or debt financing. Middle market firms’ financing requirements are too large to rely on small company capital sources and not yet large enough to access public markets in a cost-effective manner. Hence the opportunity set for private debt managers.
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