Macroeconomic implications of shadow banks: A DSGE analysis

Shadow banks have played an increasing role in the intermediation of credit as well as transmission of shocks to the rest of the economy over the last two decades. We examine the implications of these banks using a medium-scale DSGE model in which shadow banks differ from commercial banks in two aspects. First, shadow banks do not face capital requirements. Second, these banks do not receive deposit insurance from the government. Using the model, we highlight that shadow banks can mitigate the effects of an increase in capital requirements. A one percentage point increase in capital requirements leads to an annualized decline from 0.75% to around 0.05% in commercial bank default rates in the longer run. These declines in default rates are achieved with modest declines in economic activity; the change in capital requirement leads to a short-run decline in GDP of 0.6%, a long-run decline of 0.2%, and a total lending decline of 0.9%.