Banks, Shadow Banks, and Business Cycles
42 Pages Posted: 16 Feb 2021
Date Written: February 14, 2021
Credit spreads on household and business loans move in lockstep and spike in every recession. We propose a theory as to why banks tighten their lending standards following a drop in market sentiment. The key feature is a procyclical shadow banking sector that shifts risk from traditional banks to investors through securitisation. We fit the model to euro‑area data and find that market sentiment shocks are the main driver of business and financial cycles over the past two decades.
Keywords: Credit spreads, shadow banks, business cycles, financial shocks
JEL Classification: E32, E44, G21, G23
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