Morgan Stanley Reveals The Profound Implications Of Last Week's "Pivotal" Credit Deregulation Announcement

By Vishwanath Tirupattur, Chief Fixed Income Strategist at Morgan Stanley 

Last week saw a pivotal moment in financial deregulation, with the withdrawal of the 2013 leveraged lending guidelines in a joint statement from the Office of the Comptroller of the Currency (OCC) and the Federal Deposit Insurance Corporation (FDIC). The consequences for both public and private credit markets are significant. In this week’s Start, we review the historical context and offer our initial take on the implications of this shift for credit markets.

Issued in March 2013 by the Federal Reserve, FDIC, and OCC in the wake of the global financial crisis, the leveraged lending guidelines set  supervisory expectations for banks on managing risk in leveraged transactions. They emphasized sound business fundamentals, robust capital structures, and borrower repayment capacity, anchored by specific leverage metrics. Most notably, the guidelines flagged total debt-to-EBITDA ratios above 6x as a supervisory concern. In practice, this “guidance” was enforced as a de facto rule, particularly around that leverage threshold. 

Although enforcement eased over time, the 2013 guidelines fundamentally reshaped underwriting standards and influenced credit risk appetite across the financial system.

By limiting banks’ ability to underwrite highly leveraged loans, the guidelines created a vacuum that unregulated non-bank lenders were quick to fill –  catalyzing the explosive rise of private credit. Once a niche corner of the credit ecosystem, private credit has evolved into a dominant force, now  accounting for nearly a third of the leveraged finance market. At ~US$1.3 trillion outstanding, the direct lending segment of private credit is approaching the scale of US high yield bonds (US$1.4 trillion) and broadly syndicated leveraged loans (BSL; US$1.5 trillion). 

Against this backdrop, last week’s decision to rescind the guidelines marks a structural shift that could impact pricing, liquidity, and deal structures – creating new opportunities but also raising the risk of weaker lending standards. The Federal Reserve’s absence from the announcement contrasts sharply with its role in 2013. As the Wall Street Journal noted, Vice Chair for Supervision Michelle Bowman has advocated easing other bank regulations, and the Fed is expected to follow suit on leveraged lending guidance. However, withdrawing the 2013 framework may require a Board of Governors vote – a procedural hurdle that could delay implementation.

We see this change, once the Fed is on board, as credit positive and an overall fillip to credit availability that should be supportive of the broader economy, if it spurs more hiring and spending. Additionally, improved credit access for non-stressed borrowers at the lower end of the spectrum will likely prolong the credit cycle. 

This would amplify the risk-reboot sentiment in our 2026 credit outlook, where we called for high yield bonds and leveraged loans to outperform investment grade. As we didn’t assume a rollback of the guidelines, this development reinforces our conviction. That said, the near-term impact may be muted. On the surface, >6x leverage maps to low single B or CCC borrowers in public markets – names often burdened by idiosyncratic risks or punitive financing costs that easier credit access won’t solve. Instead, we see this as part of a broader set-up that supports our preference for leveraged credit over investment grade. 

We see several implications for private credit markets. The dynamic between broadly syndicated loans (BSL) and the direct lending segment of private credit offers a useful guide. In recent years, the spread differential between public (BSL) and private (direct lending) markets has narrowed, with larger companies and deals increasingly treating BSL and private credit as interchangeable financing channels. 

At the same time, an increasing share of direct lending loans has been issued without maintenance covenants, mirroring BSL structures. As the BSL market regained stability over the past two years, it clawed back some of the share lost to private credit.

A similar shift may now occur at the other end of the spectrum: smaller loans to smaller companies. Here, public markets do not compete with direct lending. For these borrowers, while bank lending slowed with the onset of the 2013 guidelines, private credit grew into the dominant option as size constraints limited public market access. These lower-tier, middle-market borrowers now stand to benefit from additional bank credit availability: The withdrawal of leveraged lending guidelines should expand the overall credit pie, though potentially loosening lending standards. Covenants for smaller borrowers have remained tight in private credit so far, but competitive pressures could lead to accommodative credit conditions.

For private credit, this shift means heightened competition for traditional direct lending mandates – in both the lower middle market as banks re- emerge as credible alternatives, and the upper middle market as public channels gain underwriting flexibility. That said, with private credit AUM increasingly driven by investors seeking “quality” exposure (e.g., insurance companies and endowments), we expect a continued pivot toward investment grade structures, particularly in asset-based finance.

More in the full Sunday Start note available to pro subs.