International shadow banking and prudential capital controls

Abstract

Shadow banks have recently led the growth in cross-border lending. With this in mind, I develop a two-country real business cycle model with commercial and shadow banking to study the business cycle implications and welfare effects of prudential capital controls. In my model, the presence of shadow banking results in leakages associated with capital controls. As a result, capital outflow restrictions result in a welfare loss in the policy source country, but a welfare improvement in the rival country. Capital inflow restrictions yield the opposite welfare effects for both countries.