The Law and Economics of Shadow Banking

The Law and Economics of Shadow Banking

Alessio Pacces, Hossein Nabilou

Series number :

Serial Number: 
339/2017

Date posted :

December 20 2016

Last revised :

April 13 2017
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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

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.

Authors

Real name: 
Hossein Nabilou
Research Member
Amsterdam Law School and Business School, University of Amsterdam