Working Paper: NBER ID: w23930
Authors: Emmanuel Farhi; Jean Tirole
Abstract: Traditional banking is built on four pillars: SME lending, insured deposit taking, access to lender of last resort, and prudential supervision. This paper unveils the logic of the quadrilogy by showing that it emerges naturally as an equilibrium outcome in a game between banks and the government. A key insight is that regulation and public insurance services (LOLR, deposit insurance) are complementary. The model also shows how prudential regulation must adjust to the emergence of shadow banking, and rationalizes structural remedies to counter financial contagion: ring-fencing between regulated and shadow banking and the sharing of liquidity in centralized platforms.
Keywords: shadow banking; financial intermediation; regulation; public insurance; lender of last resort
JEL Codes: E0; G0
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Regulation (L51) | Banking Stability (F65) |
| Public Insurance (G52) | Banking Stability (F65) |
| Regulation and Public Insurance (I18) | Banking Stability (F65) |
| Regulation (L51) | Manage Leverage (G32) |
| Manage Leverage (G32) | Likelihood of Bailouts (H81) |
| Regulation (L51) | Migration to Shadow Banking (F65) |
| Shadow Banking (G21) | Financial Contagion (F65) |
| Regulation and Public Liquidity Support (G28) | Financial Stability (G28) |