Information Gaps and Shadow Banking

75 Pages Posted: 21 Mar 2016 Last revised: 23 Mar 2017

Date Written: March 22, 2017


This Article argues that information gaps—pockets of information that are pertinent and knowable but not currently known—are a byproduct of shadow banking and a meaningful source of systemic risk. It lays the foundation for this claim by juxtaposing the regulatory regime governing the shadow banking system with the incentives of the market participants who populate that system. Like banks, shadow banks rely heavily on short-term debt claims designed to obviate the need for the holder to engage in any meaningful information gathering or analysis. The securities laws that prevail in the capital markets, however, both presume and depend on providers of capital to perform these functions. In synthesizing insights from diverse bodies of literature and situating those understandings against the regulatory architecture, this Article provides one of the first comprehensive accounts of how the information-related incentives of equity and money claimants explain many core features of securities and banking regulation.

The Article’s main theoretical contribution is to provide a new explanation for the inherent fragility of institutions that rely on money claims. The existing literature typically focuses on either coordination problems among depositors or information asymmetries between depositors and bank managers to explain bank runs. This Article provides a third explanation for why reliance on short-term debt leads to fragility, one which complements the established paradigms. First, information gaps increase the probability of panic by increasing the range of signals that can cast doubt on whether short-term debt that market participants had been treating like “money” remain sufficiently information insensitive to merit such treatment. Second, information gaps impede the market and regulatory responses that can dampen the effects of a shock once panic takes hold. Evidence from the 2007–2009 financial crisis is consistent with the Article’s claims regarding the ways shadow banking creates information gaps and how those gaps contribute to fragility.

Keywords: information sensitivity, money markets, financial regulatory structure, fragility, mutual ignorance, uncertainty

JEL Classification: D80, D81, D82, E4, E5, G14, G18, G21, G28

Suggested Citation

Judge, Kathryn, Information Gaps and Shadow Banking (March 22, 2017). Virginia Law Review, 2017, Forthcoming, Columbia Law and Economics Working Paper No. 529, Available at SSRN:

Kathryn Judge (Contact Author)

Columbia Law School ( email )

435 West 116th Street
New York, NY 10025
United States


ECGI ( email )

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels

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