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)
52 Pages Posted: 20 Dec 2016 Last revised: 13 Apr 2017
Date Written: March 26, 2017
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: Suggested Citation