Capital structure secrets from shadow banking
In this paper, Erica Jiang, Gregor Matvos, Tomasz Piskorski, and Amit Seru explore the reasons behind high financial leverage in banks compared to shadow banks. The authors assembled a novel dataset on shadow banks’ capital structure using Freedom of Information Act (FOIA) requests from state regulators. They compared this with bank data from regulatory call reports and identified banks with similar business models to shadow banks, focusing on mortgage origination and the originate-to-distribute (OTD) model. Finally, the authors developed a quantitative equilibrium model to analyze the capital structure choices of banks and shadow banks. The model accounts for the role of insured deposits, uninsured leverage, and money-like liabilities. Their key findings include:
- Capital structure differences: Shadow banks have significantly more equity capital (25% equity-to-asset ratio) compared to banks (11%), despite no capital requirements for shadow banks.
- Leverage dispersion: Shadow banks exhibit much greater dispersion in leverage than banks, reflecting more varied business strategies.
- Debt funding: Both banks and shadow banks engage in maturity transformation, using short-term debt to fund long-term loans. However, shadow bank debt is uninsured and more concentrated.
- Size and leverage: Shadow bank capitalization decreases with size, while bank capitalization remains stable. Uninsured leverage increases with size for both types.
- Interest rates: Interest rates on uninsured debt decline with size for both banks and shadow banks, but banks pay lower rates due to the perceived safety of their debt.
- Model results: The calibrated model suggests that if banks had no access to insured deposits, their average capitalization would increase by about 25% in relative terms. Small banks would see the largest increase in capitalization, while large banks’ leverage would remain relatively unchanged.
- Policy Implications: The findings suggest that smaller banks rely more heavily on safety nets, implying that capital requirements should be higher for these banks. The removal of safety nets would lead to a redistribution of lending from smaller to larger banks and the shadow banking sector, with minimal aggregate effects on lending volume.
Which Banks are (Over) Levered? Insights from Shadow Banks and Uninsured Leverage
Authors: Erica Jiang, Gregor Matvos, Tomasz Piskorski, Amit Seru
From: University of Southern California, Northwestern University, Columbia Business School, Stanford Graduate School of Business
Regulatory constraints in the face of shadow banking
This paper by Kinda Hachem and Martin Kuncl examines how shadow banking activities affect optimal financial regulation, particularly comparing state-contingent regulation (like bail-ins) with non-contingent regulation (like capital requirements). The authors develop a three-period model that allows banks to make ex-ante liquidity choices and impose ex-post haircuts on withdrawals in a stress state. Both instruments serve to reduce fire-sale losses but have different costs: liquidity holdings reduce investment returns, while haircuts create variability in creditor payoffs. The model is built in stages of increasing complexity. Beginning with a benchmark framework demonstrating the inefficiency of unregulated banks, the authors progressively incorporate shadow banking technologies, bailout options, and information asymmetries to examine how these factors constrain regulatory choices. Their key findings include:
- Optimal regulation: Without shadow activities, the planner optimally uses both non-contingent and state-contingent regulation. The choice depends on the probability and severity of the stress state.
- Shadow activities constraint: The threat of shadow activities constrains state-contingent regulation more than non-contingent regulation. This is because the marginal cost of circumventing state-contingent regulation is incurred only in the stress state and neglects the externality associated with project sales.
- Bailout effects: The planner may use bailouts instead of tightening regulation when shadow activities are a threat. Without commitment, bailouts can lead to weaker regulation and larger bailouts.
- Imperfect information: If the planner is uncertain about the costs of shadow activities, shadow activities may occur with positive probability. This increases the size of bailouts, especially for state-contingent regulation.
- Empirical evidence: The authors find evidence that banks provide more credit lines when issuing contingent convertible bonds, suggesting that these credit lines may function as insurance against regulatory haircuts, undermining the intended state-contingency of these bonds.
The Prudential Toolkit with Shadow Banking
Author: Kinda Hachem, Martin Kuncl
From: Federal Reserve Bank of New York
