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Banks, shadow banking, and fragility

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  • Luck, Stephan
  • Schempp, Paul

Abstract

This paper studies a banking model of maturity transformation in which regulatory arbitrage induces the coexistence of regulated commercial banks and unregulated shadow banks. We derive three main results: First, the relative size of the shadow banking sector determines the stability of the financial system. If the shadow banking sector is small relative to the capacity of secondary markets for shadow banks' assets, shadow banking is stable. In turn, if the sector grows too large, it becomes fragile: an additional equilibrium emerges that is characterized by a panic-based run in the shadow banking sector. Second, if regulated commercial banks themselves operate shadow banks, a larger shadow banking sector is sustainable. However, once the threat of a crisis reappears, a crisis in the shadow banking sector spreads to the commercial banking sector. Third, in the presence of regulatory arbitrage, a safety net for banks may fail to prevent a banking crisis. Moreover, the safety net may be tested and may eventually become costly for the regulator. JEL Classification: G21, G23, G28

Suggested Citation

  • Luck, Stephan & Schempp, Paul, 2014. "Banks, shadow banking, and fragility," Working Paper Series 1726, European Central Bank.
  • Handle: RePEc:ecb:ecbwps:20141726
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    Citations

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    Cited by:

    1. Duca, John V. & Ling, David C., 2015. "The other (commercial) real estate boom and bust: the effects of risk premia and regulatory capital arbitrage," Working Papers 1504, Federal Reserve Bank of Dallas, revised 01 Jun 2015.
    2. Voellmy, Lukas, 2017. "Shadow Banking and Financial Stability under Limited Deposit Insurance," Annual Conference 2017 (Vienna): Alternative Structures for Money and Banking 168262, Verein für Socialpolitik / German Economic Association.
    3. Suarez, Javier & Sánchez Serrano, Antonio, 2018. "Approaching non-performing loans from a macroprudential angle," Report of the Advisory Scientific Committee 7, European Systemic Risk Board.
    4. Aizenman, Joshua & Binici, Mahir, 2016. "Exchange market pressure in OECD and emerging economies: Domestic vs. external factors and capital flows in the old and new normal," Journal of International Money and Finance, Elsevier, vol. 66(C), pages 65-87.
    5. Kraemer-Eis, Helmut & Battazzi, Francesco & Charrier, Remi & Natoli, Marco & Squilloni, Matteo, 2014. "Institutional non bank lending and the role of debt funds," EIF Working Paper Series 2014/25, European Investment Fund (EIF).
    6. E. Chrétien & V. Lyonnet, 2017. "Traditional and Shadow Banks during the Crisis," Débats économiques et financiers 27, Banque de France.
    7. Michael Funke & Petar Mihaylovski & Haibin Zhu, "undated". "Monetary policy transmission in China: A DSGE model with parallel shadow banking and interest rate control," GRU Working Paper Series GRU_2016_007, City University of Hong Kong, Department of Economics and Finance, Global Research Unit.
    8. Konstantin Kosenko & Noam Michelson, 2018. "It Takes More than Two to Tango: Understanding the Dynamics behind Multiple Bank Lending and its Implications," Bank of Israel Working Papers 2018.11, Bank of Israel.
    9. Antonio Bianco, 2015. "Shadow banking, relationship banking, and the economics of depression," PSL Quarterly Review, Economia civile, vol. 68(275), pages 297-326.
    10. Bianco, Antonio, 2015. "Relationship Banking, Shadow Banking, and the Economics of Depression," MPRA Paper 65849, University Library of Munich, Germany.
    11. Stephanie Chan & Sweder van Wijnbergen, 2014. "Cocos, Contagion and Systemic Risk," Tinbergen Institute Discussion Papers 14-110/VI/DSF79, Tinbergen Institute, revised 29 Oct 2014.
    12. Flore, Raphael, 2015. "Causes of Shadow Banking - Two Regimes of Credit Risk Transformation and its Regulation," Annual Conference 2015 (Muenster): Economic Development - Theory and Policy 113178, Verein für Socialpolitik / German Economic Association.
    13. Poeschl, Johannes & Zhang, Xue, 2018. "Bank Capital Regulation and Endogenous Shadow Banking Crises," MPRA Paper 92529, University Library of Munich, Germany.
    14. repec:kap:jfsres:v:55:y:2019:i:1:d:10.1007_s10693-017-0277-2 is not listed on IDEAS
    15. repec:eee:jetheo:v:178:y:2018:i:c:p:124-152 is not listed on IDEAS
    16. Angus Armstrong & Tatiana Fic, 2014. "Bank Diversification and Valuation: International Evidence," National Institute of Economic and Social Research (NIESR) Discussion Papers 438, National Institute of Economic and Social Research.

    More about this item

    Keywords

    bank runs; financial crisis; maturity transformation; regulatory arbitrage; shadow banking;

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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