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Monetary Transmission through Shadow Banks

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  • Kairong Xiao

Abstract

This paper documents a new transmission channel of monetary policy: the shadow money channel. Analyzing U.S. money supply data from 1987 to 2012, I find that shadow money, namely liquid deposits created by shadow banks, expands significantly when the Federal Reserve tightens monetary policy. Using a structural model of bank competition, I show that this new channel is a result of imperfect competition between commercial and shadow banks in the deposit market with heterogeneous depositors. Due to a lack of a bank charter, shadow banks offer lower transaction convenience and hence must compete on yields. During periods of monetary tightening, shadow banks pass through more rate hikes to depositors, thereby poaching yield-sensitive deposits from commercial banks. Fitting my model to institution-level data from commercial banks and money market funds, I show that shadow money creation offsets 35 cents of each dollar in commercial bank deposit reductions, significantly dampening the impact of monetary tightening. My results suggest that monetary tightening may unintentionally drive more deposits into the uninsured shadow banking sector, thereby amplifying the risk of bank runs.

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  • Kairong Xiao, 2018. "Monetary Transmission through Shadow Banks," 2018 Meeting Papers 616, Society for Economic Dynamics.
    • Handle: RePEc:red:sed018:616
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    Cited by:

    1. Kent Daniel & Lorenzo Garlappi & Kairong Xiao, 2021. "Monetary Policy and Reaching for Income," Journal of Finance, American Finance Association, vol. 76(3), pages 1145-1193, June.
    2. Albertazzi, Ugo & Barbiero, Francesca & Marqués-Ibáñez, David & Popov, Alexander & Rodriguez d’Acri, Costanza & Vlassopoulos, Thomas, 2020. "Monetary policy and bank stability: the analytical toolbox reviewed," Working Paper Series 2377, European Central Bank.
    3. Saibal Ghosh, 2022. "Does financial interconnectedness affect monetary transmission? Evidence from India," Macroeconomics and Finance in Emerging Market Economies, Taylor & Francis Journals, vol. 15(3), pages 273-300, September.
    4. Istiak, Khandokar, 2019. "The nature of shadow bank leverage shocks on the macroeconomy," The North American Journal of Economics and Finance, Elsevier, vol. 50(C).
    5. Aguirregabiria, Victor & Clark, Robert & Wang, Hui, 2019. "The Geographic Flow of Bank Funding and Access to Credit: Branch Networks, Local Synergies, and Competition," CEPR Discussion Papers 13741, C.E.P.R. Discussion Papers.
    6. Greg Buchak & Gregor Matvos & Tomasz Piskorski & Amit Seru, 2018. "Beyond the Balance Sheet Model of Banking: Implications for Bank Regulation and Monetary Policy," NBER Working Papers 25149, National Bureau of Economic Research, Inc.
    7. Itamar Drechsler & Alexi Savov & Philipp Schnabl, 2019. "How Monetary Policy Shaped the Housing Boom," NBER Working Papers 25649, National Bureau of Economic Research, Inc.
    8. Schnabl, Philipp & Savov, Alexi, 2019. "How Monetary Policy Shaped the Housing Boom," CEPR Discussion Papers 14252, C.E.P.R. Discussion Papers.

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