The world needs massive capital expenditure for data centers, energy, and the reshoring of industry to domestic markets. The open question is: who is going to finance it?

Freshly emboldened US banks look set to take some of the opportunities under the more benign regulatory backdrop of the new administration in Washington. The sector’s share price gains since the US election suggest investors expect there will be more leeway in general to deploy capital more profitably.

Morgan Stanley estimates that if the Basel III global rules for banks are implemented in a “capital neutral” way — that is, with no net increase in capital demands — in the US, it could free up more than $86 billion of capital for the top 12 banks for financings or buybacks.

Private credit’s profound funding shift — data centers, energy, and reshoring of industry

But we think banks are more likely to put fresh capital to work in large loans for leveraged buyouts and other deals — leaving a still-sizable gap in asset-based lending and capex funding. Private credit players, with an assist from insurers, are likely to help fill that void.

The top seven listed private credit firms now have $2.1 trillion in credit assets between them, including infrastructure and real estate debt. But traditional private credit markets are becoming more crowded and are likely to become picked over more by banks as they rebuild capacity in a lighter regulatory climate. As a result, some private credit firms are striking out for greener pastures. Leading players are pivoting to become less dependent on mid-market lending and acquisition finance and starting to become capex financiers.

The US is expected to see more than $1 trillion invested in data centers over the next five years, with an additional $1 trillion invested internationally, catering to the surging demand for cloud computing and AI applications, according to Blackstone. The energy required for all this will require additional investments — as will the transition to greener sources of power and increased energy demand in general.

Apollo Global Chief Executive Marc Rowan argues we may see private project finance deals as big as $15 to $20 billion in the next year. These assets are complex and long-dated, and demand innovative financing solutions that do not always easily align with traditional banking or debt markets. Private credit currently accounts for only about 5% of the $5.5 trillion speciality finance market.  And the share is even lower for energy infrastructure.

Insurance assets are fueling private credit’s growth

However, a profound shift in the funding model of private credit is now spurring expansion. Our new research suggests private credit assets funded by insurers at the top seven listed private market players now account for 43% of credit assets held by these firms, up from 32% at the end of 2021. This provides a source of long-term, stable capital to invest. Put another way, more than half of all inflows in 2024 came from insurers.

Insurers require investment in long-duration assets that are inflation-resistant and high quality. BlackRock Chief Financial Officer Martin Small has spoken of the potential to flip 10% of its $700 billion insurance assets from core fixed-income to private credit. This was a key part of the rationale of BlackRock’s $12 billion acquisition of private credit firm HPS. Northwestern Mutual also struck a deal with Sixth Street to manage $13 billion of its assets.

Such insurance capital is transforming the types of projects private credit can back. For example, insurers prioritize steady 7% to 9% returns that align well with the needs of long-duration infrastructure financing. In some ways, this represents a return to an older financing model. After World War II, large insurers financed and even owned transformative infrastructure projects and utilities.

Three surprises that could impact the private credit landscape

Our base case is that private credit players and insurers will become bigger participants in infrastructure financings. But there are numerous risks to navigate in the provision of private credit for coming investment needs, such as the quality of borrowers. And two surprises could pose major obstacles.

1. Banks don’t recede as expected

While it’s likely that banks will devote more attention to leveraged finance in the next four years, dealmaking could slow, leaving them with more capital than expected for asset-based lending.

2. European regulators pivot

The base case, based on past experience, is for slow, incremental change in Solvency II, not least because it has been looked at several times. But the scale of infrastructure spending, and the Trumpification of politics, could catalyze a much sharper reaction, and Solvency II could be recalibrated to promote insurers’ being able to fund securitizations (especially mezzanine senior tranches) and private credit.

3. Private credit has large credit challenges

Higher interest rates from inflationary policies could also put more pressure on the balance sheets of private credit loans. This could slow the inflows of credit and challenge returns.

While plausible, those scenarios aren’t likely. Over the next four years it’s a decent bet that private credit and insurers will play a growing role in financing the capex boom.

A version of this was originally published in the Financial Times (paywall).

This article is part of our Known Unknowns report highlighting the debates that will shape the future of financial services