Shadow Banking and Financial Stability Under Limited Deposit Insurance

49 Pages Posted: 5 Nov 2020

Date Written: December, 2019

Abstract

I study the relation between shadow banking and financial stability in an economy in which banks are susceptible to self-fulfilling runs and in which government-backed deposit insurance is limited. Shadow banks issue only uninsured deposits while commercial banks issue both insured and uninsured deposits. The effect of shadow banking on financial stability is ambiguous and depends on the (exogenous) upper limit on insured deposits. If the upper limit on insured deposits is high, then the presence of a shadow banking sector is detrimental to financial stability; shadow banking creates systemic instability that would not be present if all deposits were held in the commercial banking sector. In contrast, if the upper limit on insured deposits is low, then the presence of a shadow banking sector is beneficial from a financial stability perspective; shadow banks absorb uninsured (and uninsurable) deposits from the commercial banking sector, thereby shielding commercial banks from runs. While runs may occur in the shadow banking sector, the situation without shadow banks and a larger amount of uninsured deposits held at commercial banks is worse.

Keywords: bank runs, deposit insurance, financial intermediation, shadow banking

JEL Classification: E44, G21, G28

Suggested Citation

Voellmy, Lukas, Shadow Banking and Financial Stability Under Limited Deposit Insurance (December, 2019). ESRB: Working Paper Series No. 2019/105, Available at SSRN: https://ssrn.com/abstract=3723441 or http://dx.doi.org/10.2139/ssrn.3723441

Lukas Voellmy (Contact Author)

Swiss National Bank ( email )

Research
Fraumuensterstr. 8
Zuerich, 8022
Switzerland

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