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Mortgage debt and shadow banks

Sebastiaan Pool

DNB Working Papers from Netherlands Central Bank, Research Department

Abstract: Since the 1980s, the global banking sector has been characterized by three trends: i) a secular decline in interest rates, ii) a reallocation of bank investments from corporate loans towards mortgages and iii) the rise of shadow banking relative to regulated banking. This paper builds a general equilibrium framework that connects, analyzes and explains these trends in a causal way. In the model, exogenous downward pressure on real interest rates increases the share of mortgage investments. Consequently, the interbank market for mortgage securities becomes more liquid. This increases funding liquidity and shadow banks gain comparative advantage over regulated banks with respect to the supply of mortgage loans. In relative terms, the shadow banking sector grows. Meanwhile, the economy becomes more vulnerable to financial crises as shadow banks issue too many uninsured deposits. To enhance financial stability, I consider restrictions on admissible loan-to-value ratios for mortgage loans to reduce house price and mortgage supply fluctuation. Finally, I suggest to introduce interest-paying central bank deposits for households to raise the costs for banks to finance themselves with uninsured deposits.

Keywords: Shadow Banking; Regulated Banking; Financial Stability (search for similar items in EconPapers)
JEL-codes: E44 G10 G21 G23 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-ban and nep-mac
Date: 2018-03
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Persistent link: https://EconPapers.repec.org/RePEc:dnb:dnbwpp:588

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