Monetary Transmission through Shadow Banks

Abstract

This paper documents a new transmission channel of monetary policy: the shadow money channel. Analyzing U.S. money supply data from 1987 to 2012, I find that shadow money, namely liquid deposits created by shadow banks, expands significantly when the Federal Reserve tightens monetary policy. Using a structural model of bank competition, I show that this new channel is a result of imperfect competition between commercial and shadow banks in the deposit market with heterogeneous depositors. Due to a lack of a bank charter, shadow banks offer lower transaction convenience and hence must compete on yields. During periods of monetary tightening, shadow banks pass through more rate hikes to depositors, thereby poaching yield-sensitive deposits from commercial banks. Fitting my model to institution-level data from commercial banks and money market funds, I show that shadow money creation offsets 35 cents of each dollar in commercial bank deposit reductions, significantly dampening the impact of monetary tightening. My results suggest that monetary tightening may unintentionally drive more deposits into the uninsured shadow banking sector, thereby amplifying the risk of bank runs.