Working Paper: NBER ID: w17115
Authors: Nicola Gennaioli; Andrei Shleifer; Robert W. Vishny
Abstract: We present a model of shadow banking in which financial intermediaries originate and trade loans, assemble these loans into diversified portfolios, and then finance these portfolios externally with riskless debt. In this model: i) outside investor wealth drives the demand for riskless debt and indirectly for securitization, ii) intermediary assets and leverage move together as in Adrian and Shin (2010), and iii) intermediaries increase their exposure to systematic risk as they reduce their idiosyncratic risk through diversification, as in Acharya, Schnabl, and Suarez (2010). Under rational expectations, the shadow banking system is stable and improves welfare. When investors and intermediaries neglect tail risks, however, the expansion of risky lending and the concentration of risks in the intermediaries create financial fragility and fluctuations in liquidity over time.
Keywords: shadow banking; financial intermediaries; riskless debt; securitization; financial stability
JEL Codes: E44; G01; G21
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| increased outside investor wealth (G19) | demand for riskless debt (E41) |
| demand for riskless debt (E41) | behavior of financial intermediaries (G21) |
| increased outside investor wealth (G19) | behavior of financial intermediaries (G21) |
| increased demand for riskless debt (E41) | intermediaries diversify their portfolios (G11) |
| intermediaries diversify their portfolios (G11) | reduce idiosyncratic risk (G40) |
| reduce idiosyncratic risk (G40) | increase exposure to systematic risk (G19) |
| neglect of tail risks (D81) | overextension of intermediaries' balance sheets (F65) |
| overextension of intermediaries' balance sheets (F65) | collapse of shadow banking system (F65) |
| expansion of risky lending (F65) | concentration of risks in intermediaries (F65) |
| neglect of tail risks (D81) | misallocation of risks (D61) |
| misallocation of risks (D61) | excessive risk-taking by intermediaries (F65) |
| neglect of tail risks (D81) | systemic failure likelihood increases (P17) |