By Hélène Desgagnés
I examine the impact of non-regulated lenders in the mortgage market using a dynamic stochastic general equilibrium (DSGE) model. My model features two types of financial intermediaries that differ in three ways: (i) only regulated intermediaries face a capital requirement, (ii) non-regulated intermediaries finance themselves by selling securities and cannot accept deposits, and (iii) non-regulated intermediaries face a more elastic demand. This last assumption is based on empirical evidence for Canada revealing that non-regulated intermediaries issue loans at a lower interest rate. My results suggest that the non-regulated sector contributes to stabilize the economy by providing an alternative source of capital when the regulated sector in unable to fulfill the demand for credit. As a result, an economy with a large non-regulated sector experiences a smaller downturn after an adverse financial shock.
As I was reading this abstract, its conclusion caught me completely wrong-footed. Why would you want a large unregulated financial sector? Well, of course, the larger it is the more it can lend and at lower cost. But this hides the reason that regulation is put in place: to avoid systemic crashes. Those events seems to be absent from considerations in this paper. Its financial shock is just a perturbation to the cost of capital, and thus unlikely to trigger a financial crisis. The paper is thus not turning everything I knew about banking upside down after all.