Collaborative Research: Direct Lending in the U.S. Middle Market

Abstract The tightening of regulation in the U.S. banking sector following the Financial Crisis of 2008 contributed to a surge of alternative nonbank lenders and, in particular, business development companies (BDCs). This sector has expanded rapidly over the last two decades. This project will construct an extensive database and conduct the first systematic analysis of the BDC sector. The project will focus on these new lenders and provide insights into an important yet understudied segment of the U.S. economy - the middle market, which accounts for a third of private-sector employment. Specifically, the project will investigate the impact of nonbank lending on middle-market firms and economic growth. Overall, the project will have important policy implications for the role of financial intermediation in the economy. By constructing a novel database, this project will advance the body of knowledge on nonbank lending. First, the project will investigate the causes of the BDC sector growth and analyze their role in financing middle-market firms. The granularity of the dataset will additionally allow to characterize the borrowers targeted and lending solutions offered. Second, the project will use the location information of BDC portfolio companies to estimate the real effects of these direct lenders on middle-market firms and, more broadly, on local economic growth. Third, the project will investigate how access to capital markets affects investment activities of direct lenders. Finally, since BDCs provide funding to firms without relying on deposit insurance, they put forward a new lending model that may offer an improvement to the current deposit-based banking system. To understand the effects of this alternative lending mechanism, the project will develop a quantitative framework to conduct a welfare analysis of transitioning to a new lending environment. This award reflects NSF's statutory mission and has been deemed worthy of support through evaluation using the Foundation's intellectual merit and broader impacts review criteria.