The Law and Economics of Shadow Banking

Forthcoming in Iris H. Chiu & Iain MacNeil (eds.), Research Handbook on Shadow Banking: Legal and Regulatory Aspects, Edward Elgar (2017)

European Corporate Governance Institute (ECGI) - Law Working Paper No. 339/2017

52 Pages Posted: 20 Dec 2016 Last revised: 13 Apr 2017

Alessio M. Pacces

Erasmus School of Law, Erasmus University Rotterdam - Rotterdam Institute of Law and Economics; European Corporate Governance Institute

Hossein Nabilou

University of Luxembourg; Faculty of Law, Economics and Finance

Date Written: March 26, 2017

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.

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

JEL Classification: G01, G23, G28, K22, K23

Suggested Citation

Pacces, Alessio M. and Nabilou, Hossein, The Law and Economics of Shadow Banking (March 26, 2017). Forthcoming in Iris H. Chiu & Iain MacNeil (eds.), Research Handbook on Shadow Banking: Legal and Regulatory Aspects, Edward Elgar (2017); European Corporate Governance Institute (ECGI) - Law Working Paper No. 339/2017. Available at SSRN: https://ssrn.com/abstract=2884374

Alessio Maria Pacces (Contact Author)

Erasmus School of Law, Erasmus University Rotterdam - Rotterdam Institute of Law and Economics ( email )

Burgemeester Oudlaan 50
P.O. Box 1738
Rotterdam, Zuid Holland 3000 DR
Netherlands
+31-(0)10-4081613 (Phone)
+31-(0)10-4089191 (Fax)

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European Corporate Governance Institute ( email )

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

Hossein Nabilou

University of Luxembourg; Faculty of Law, Economics and Finance ( email )

4 Rue Alphonse Weicker
Office: B203
Luxembourg, L-2721
Luxembourg
+352 46 66 44 5450 (Phone)
+352 46 66 44 35450 (Fax)

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