Working Paper: NBER ID: w19022
Authors: Guillermo Ordonez
Abstract: Commercial banks are subject to regulation that restricts their investments. When banks are concerned for their reputation, however, they could self-regulate and invest more efficiently. Hence, a shadow banking that arises to avoid regulation has the potential to improve welfare. Still, reputation concerns depend on future economic prospects and may suddenly disappear, generating a collapse of shadow banking and a return to traditional banking, with a decline in welfare. I discuss how a combination of traditional regulation and cross reputation subsidization may enhance shadow banking and make it more sustainable.
Keywords: shadow banking; reputation; financial regulation; self-regulation; capital requirements
JEL Codes: D82; E44; G01; G18; G21
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Reputation concerns (D83) | Banks' risk-taking behavior (G21) |
| Good future economic prospects (P17) | Banks' investment decisions (G21) |
| Bad news about future economic conditions (E66) | Excessive risk-taking (D81) |
| Reputation concerns collapse (G33) | Flight of investors back to traditional banking (G21) |
| Collapse of reputation (Z13) | Decline in welfare (I38) |
| Capital requirements + Cross-subsidization (G32) | Enhanced sustainability of shadow banking (F65) |