Low interest rates and the rise of shadow banks
In this paper, Sarto and Wang argue that the persistent decline in interest rates has led to the rise in shadow banking. The authors study jointly the harmful effects of lower rates on bank lending and the response of non-banks. They develop a simplified model of the competition between traditional and shadow banks in loan origination, and how it is affected by changes in regulation, technology, and interest rates. They find that:
Shadow banks have no access to cheap deposits, hence they must fund themselves at higher rates than their bank competitors. Since the spread between market rates and deposit rates is higher at high interest rates, the competitive disadvantage faced by shadow banks is more severe in a high rate environment. Conversely, as interest rates fall, the funding disadvantage of shadow banks disappears, which helps them grow relative to traditional banks.
The Secular Decline in Interest Rates and the Rise of Shadow Banks
Authors: Andrés Sarto, Olivier Wang
From: New York University – Stern
Deregulation and the increase in shadow banking
The conventional view is that tight regulation led to the rise of shadow banking or non-bank intermediaries, but this paper presents a model and empirical evidence that also de-regulation leads to the same effect.
In this paper Chen et al. use data from the Shared National Credit (SNC) program to show that bank de-regulation in the form of the repeal of the Glass-Steagall Act facilitated the entry of non-bank intermediaries into the market for corporate credit during the pre2008 credit boom. The repeal led to the formation of universal banks, a type of bank that participates in many kinds of banking activities and is both a commercial bank and an investment bank. These banks can efficiently monitor even when they retain relatively low loan shares because they realize economies of scope across lending and underwriting services. As a result, institutional investors trust a stand-alone commercial bank to do so. They estimate bank-scope deregulation to have generated additional liquidity in the syndicated-loan market amounting up to $388bn, and at least $119bn even when holding credit demand fixed, over the period 1996-2008. This is sizable compared to the 2008 total amount of approximately $1.9tn (all in 2023 dollars) of corporate bonds outstanding on the books of some of the largest institutional investors.
More broadly, our results indicate that regulation shapes the industrial organization of lending markets in complex ways so that the tightness of regulation is not a sufficient statistic for predicting the migration of specific activities to the non-bank sector.
Less Bank Regulation, More Non-Bank Lending
Authors: Mary Chen, Seung Jung Lee, Daniel Neuhann, Farzad Saidi
From: Federal Reserve Bank of Boston, Federal Reserve Board of Governors, University of Texas at Austin, University of Bonn
