How Shadow Banking Reshapes the Optimal Mix of Regulation

Kinda Hachem

No 20250716, Liberty Street Economics from Federal Reserve Bank of New York

Abstract: Decisions that are privately optimal often impose externalities on other agents, giving rise to regulations aimed at implementing socially optimal outcomes. In the banking industry, regulations are particularly heavy, plausibly reflecting a view by regulators that the relevant externalities could culminate in financial crises and destabilize the broader economy. Over time, the toolkit for regulating banks and bank-like institutions has expanded, as has banks’ restructuring of activities into shadow banking to lessen the regulatory burden. This post, based on our recent Staff Report, explores the optimal mix of prudential tools for bank regulators in a wide range of environments.

Keywords: banking; shadow banking; optimal regulation; pecuniary externality; bailout; Bail-in (search for similar items in EconPapers)
JEL-codes: E61 G21 (search for similar items in EconPapers)
Date: 2025-07-16
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