Shadow banks and macroeconomic instability

By Roland Meeks, Benjamin Nelson and Piergiorgio Alessandri

http://d.repec.org/n?u=RePEc:bdi:wptemi:td_939_13&r=dge

We develop a macroeconomic model in which commercial banks can offload risky loans onto a “shadow” banking sector and financial intermediaries trade in securitized assets. We analyze the responses of aggregate activity, credit supply and credit spreads to business cycle and financial shocks. We find that interactions and spillover effects between financial institutions affect credit dynamics, that high leverage in the shadow banking system heightens the economy’s vulnerability to aggregate disturbances, and that following a financial shock, a stabilization policy aimed solely at the securitization markets is relatively ineffective.

Not only does this paper include a financial sector, nowadays a must for any macro model looking at the recent sector, this model also includes securitization and shadow banking. The latter arises as a better way to leverage illiquid loans. Banks try to transfer risk to their shadow operations, but not explicitly because of regulation. In fact, there is no regulatory motive to shadow banking in this paper, something that would be much beyond its current complexity. This paper is an interesting modeling strategy trying to push the envelope further in integrating the financial sector in macro models.