By Patrick Fève and Olivier Pierrard
In this paper, we revisit the role of regulation in a small-scale dynamic stochastic general equilibrium (DSGE) model with interacting traditional and shadow banks. We estimate the model on US data and we show that shadow banking interferes with macro-prudential policies. More precisely, asymmetric regulation causes a leak towards shadow banking which weakens the expected stabilizing effect. A counterfactual experiment shows that a regulation of the whole banking sector would have reduced investment fluctuations by 10% between 2005 and 2015. Our results therefore suggest to base regulation on the economic functions of financial institutions rather than on their legal forms.
Regulators and banks play a cat and mouse game, and I wonder whether to adopt a rule like “if it looks like a bank, regulate as a bank” would work. But this is a good attempt at tackling the shadow banking sector, which is difficult to track properly both in real life and as a modeler.