Financial regulation: what are the new risks?

[…] although significant progress was made in the financial regulatory framework following the crisis, there are now different challenges that require the attention of regulators. One key challenge is the growing importance of non-bank financial intermediaries, whose total assets are now 50 percent above their 2008 level.

[Loan-to-value ratios] directly affect the borrower choice on whether to obtain loans in the shadow or regulated banking sector because of the presence of collateral constraints. When there is a decrease in the banking sector LTV, borrowers will prefer to borrow from private lenders instead, that is, credit will flow to the industry that is less regulated. On the other hand, results also show that if Basel regulation could also be applied to the shadow banking sector, it would be more effective in achieving its macroprudential goal of bringing a more stable financial system.

Intermediation activities which require on balance sheet financing do not migrate to the shadow bank sector, suggesting that deposit taking institutions retain an advantage in balance-sheet intensive activities. We illustrate that ignoring differences in endogenous substitutability between banks and shadow banks alters the qualitative and quantitative inferences on equilibrium quantity, price, and distribution of credit resulting from different policies, and misestimates the impact of policies on bank stability as well as on distributional consequences.