Why do Traditional and Shadow Banks Coexist?

Abstract

This paper shows that traditional and shadow banks interacted in similar ways in the 2007 and COVID-19 crises, when both assets and liabilities flew out of shadow banks and into traditional banks. We explain this finding in a model of the coexistence of traditional and shadow banks in which liabilities and assets flow from the former to the latter in good times to avoid regulation, and the other way in a crisis to alleviate fire sales. The model sheds light on the (unintended) consequences of regulations for traditional banks on the shadow banking sector.

Keywords: Traditional banks, Shadow banks, Financial crisis, Deposit insurance

JEL Classification: G01, G21, G23, G38