Shadow Banking and Market Discipline on Traditional Banks

61 Pages Posted: 10 Nov 2017 Last revised: 14 May 2019

See all articles by Anil Ari

Anil Ari

International Monetary Fund

Matthieu Darracq Paries

European Central Bank (ECB)

Christoffer Kok

European Central Bank (ECB)

Dawid Żochowski

European Central Bank

Multiple version iconThere are 2 versions of this paper

Date Written: April 10, 2019

Abstract

We present a model in which shadow banking arises endogenously and undermines market discipline on traditional banks. Demandable deposits impose market discipline: Without shadow banking, traditional banks optimally pursue a safe portfolio strategy to prevent early withdrawals. Shadow banking constitutes an alternative banking strategy that combines high risk-taking with early liquidation in times of crisis. In equilibrium, shadow banks expand until their liquidation causes a fire-sale and exposes traditional banks to liquidity risk. Higher deposit rates in compensation for liquidity risk deter early withdrawals, undermining market discipline on traditional banks. Constrained-optimal policy interventions deter entry into shadow banking.

Keywords: Shadow banking, financial crisis, market discipline, fire-sales

JEL Classification: E44, E58, G01, G21, G23, G28

Suggested Citation

Ari, Anil and Darracq Paries, Matthieu and Kok, Christoffer and Żochowski, Dawid, Shadow Banking and Market Discipline on Traditional Banks (April 10, 2019). Available at SSRN: https://ssrn.com/abstract=3068550 or http://dx.doi.org/10.2139/ssrn.3068550

Anil Ari (Contact Author)

International Monetary Fund ( email )

700 19th Street NW
Washington, DC 20431
United States

HOME PAGE: http://https://sites.google.com/site/anlari/

Matthieu Darracq Paries

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany
+496913446631 (Phone)
+496913447604 (Fax)

Christoffer Kok

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Dawid Żochowski

European Central Bank ( email )

Sonnemannstrasse 20
Frankfurt am Main, 60314
Germany

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