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How Shadow Banking Reshapes the Optimal Mix of Regulation

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Abstract

Decisions that are privately optimal often impose externalities on other agents, giving rise to regulations aimed at implementing socially optimal outcomes. In the banking industry, regulations are particularly heavy, plausibly reflecting a view by regulators that the relevant externalities could culminate in financial crises and destabilize the broader economy. Over time, the toolkit for regulating banks and bank-like institutions has expanded, as has banks’ restructuring of activities into shadow banking to lessen the regulatory burden. This post, based on our recent Staff Report, explores the optimal mix of prudential tools for bank regulators in a wide range of environments.

Suggested Citation

  • Kinda Hachem, 2025. "How Shadow Banking Reshapes the Optimal Mix of Regulation," Liberty Street Economics 20250716, Federal Reserve Bank of New York.
    • Handle: RePEc:fip:fednls:101335
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    More about this item

    Keywords

    banking; shadow banking; optimal regulation; pecuniary externality; bailout; Bail-in;
    All these keywords.

    JEL classification:

    • E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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