Shadow Banking, Capital Requirements and Monetary Policy

I construct a model of the ABCP market to capture the trade-offs between traditional and shadow banks. While traditional banks are better equipped in collecting private information, shadow banks can finance more entrepreneurs’ projects since the capital requirements for loans to shadow banks are laxer than those for regular loans. First, the credit risk diminishes the lending capacity of shadow banks, yet it does not activate traditional loans. An increase in the monitoring cost of shadow banks might shift credit from shadow to traditional banks; however, traditional banks cannot restore credit to a level consistent with that initially achieved by shadow banks. Second, the central bank’s private asset purchases transfer credit from traditional to shadow banks and increase the size of funded projects when frictions are moderate in the shadow banking sector. Third, in the case of highly information-sensitive shadow loans, a decrease in the interest rate on reserves improves the lending capacity of shadow banks more than that of traditional banks.