Securitization, Shadow Banking, and Bank Regulation

Abstract

This paper studies the capital regulation of banks that choose whether to become traditional, deposit taking banks or shadow banks that provide credit intermediation through securitization. If capital regulation only covers traditional banks, it will lead to the emergence of excessively risky shadow banks that can fully crowd out traditional banking. Optimal capital regulation includes shadow banks and can prevent excessive risk taking and crowding-out by ensuring that banks' equity per unit of investment remains the same for all securitization strategies. Capital requirements cause underinvestment that cannot be mitigated by securitization.