The Implicit Guarantee Channel: How Policy Uncertainty Affects Shadow Banks

Abstract

We study the impact of policy uncertainty on shadow banking activities. When policy uncertainty heightens, banks set higher return targets when issuing new off-balance sheet shadow products. Concurrently, they extend stronger implicit guarantees to maturing products, signaling product safety and reassuring investors during uncertain times. When banks provide stronger implicit guarantees, policy uncertainty triggers risk spillovers from the shadow banking sector to the wider banking system, undermining financial stability. Consequently, our findings shed light on the post-crisis regulatory guidelines concerning step-in risk.

Keywords: Shadow Banking, Implicit Guarantee, Private Safe Asset, Policy Uncertainty

JEL Classification: G21, G23, G28