Discussion paper

DP13248 Markets, Banks, and Shadow Banks

We analyze the effect of bank capital requirements on the structure and risk of a financial system where markets, regulated banks, and shadow banks coexist. Banks face a moral hazard problem in screening entrepreneurs' projects, and they choose whether to be regulated or not. If regulated, a supervisor certifies their capital; if not, they have to rely on more expensive private certification. Under both risk-insensitive and risk-sensitive requirements, safer entrepreneurs borrow from the market and riskier entrepreneurs borrow from banks. But risk-insensitive (sensitive) requirements are especially costly for relatively safe (risky) entrepreneurs, which may shift from regulated to shadow banks.

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Citation

Martinez-Miera, D and R Repullo (eds) (2018), “DP13248 Markets, Banks, and Shadow Banks”, CEPR Press Discussion Paper No. 13248. https://cepr.org/publications/dp13248