Law Series

The Law and Economics of Shadow Banking

Series number:

339/2017

Date published:

Last revised:

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Categories

Banking
Capital
Leverage

Keywords

Shadow Banking, Maturity Transformation, safe assets, leverage, liquidity, collateral, haircut, Externalities, quantity regulation, Pigovian tax, Money Market Mutual Funds, repo, derivatives, central clearing, qualified financial contracts

Keywords

Shadow Banking, Maturity Transformation, safe assets, leverage, liquidity, collateral, haircut, Externalities, quantity regulation, Pigovian tax, Money Market Mutual Funds, repo, derivatives, central clearing, qualified financial contracts

Abstract

This essay discusses the economic case for regulating shadow banking. Focusing on systemic risk, shadow banking is defined as leveraging on collateral to support liquidity promises. Regulating shadow banking is efficient because of the negative externality stemming from systemic risk. However, because uncertainty undermines the precise measurement of systemic risk, quantity regulation is preferable to a Pigovian tax to cope with this externality. This paper argues that regulation should limit the leverage of shadow banking mainly by imposing a minimum haircut regulation on the assets being used as collateral for funding.

© Alessio Pacces, Hossein Nabilou, 2016
All rights reserved. Distributed for discussion purposes only; not to be reproduced without permission. The views expressed are those of the author(s) and do not necessarily reflect those of ECGI or its members. For copyright queries or takedown requests, contact wp@ecgi.org.

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