Implications of Shadow Bank Regulation for Monetary Policy at the Zero Lower Bound

Transcription

1 SFB 649 Discussion Paper Implicaions of Shadow Bank Regulaion for Moneary Policy a he Zero Lower Bound Falk Mazelis* * Humbold-Universiä zu Berlin, Germany SFB E C O N O M I C R I S K B E R L I N This research was suppored by he Deusche Forschungsgemeinschaf hrough he SFB 649 "Economic Risk". hp://sfb649.wiwi.hu-berlin.de ISSN SFB 649, Humbold-Universiä zu Berlin Spandauer Sraße 1, D-1178 Berlin

2 Implicaions of Shadow Bank Regulaion for Moneary Policy a he Zero Lower Bound Falk Mazelis 11 Ocober 216 Absrac Couner o he credi channel of moneary ransmission, moneary policy ighening induces a rise in lending by wo differen ypes of non-bank financial insiuions (NBFI): shadow banks and invesmen funds. A moneary DSGE model is able o replicae he empirical facs when augmened wih inermediaries ha allow for regulaory arbirage on he one hand, and household porfolio rebalancing on he oher. Therefore NBFI reduce he effeciveness of he bank lending channel, which posis a decrease in bank lending following moneary ighening. Given he pending regulaion of he financial sysem, I sudy how regulaion of he shadow banking secor may affec he moneary ransmission mechanism, especially during a zero lower bound (ZLB) episode. I find ha bringing shadow banks back ono he balance shees of commercial banks is beneficial for consumpion smoohing. Alernaively, regulaing hem like invesmen funds resuls in a milder recession during, and a quicker escape from, he ZLB. This is because a large demand shock ha moves he economy o he ZLB acs in a similar way o a moneary ighening due o he inabiliy o lower he policy rae o he unconsrained level. Consequenly, he bank lending channel becomes operaional and is effeciveness can be reduced via less reliance on deposi funding. Keywords: Shadow Banking, Zero Lower Bound, Moneary Policy, Bank Lending Channel, Bayesian Mehods, Search Fricions JEL Classificaion: E32, E44, E52, G11 I hank Julien Alberini, Jaroslav Borovicka, Markus Brunnermeier, Michael Burda, Ivan Jaccard, Peer Karadi, Laura Kodres, Perry Mehrling, Zolan Pozsar, Richard Rogerson, Lukas Schmid, Frank Schorfheide, Chris Sims, Luz Weinke and Moohiro Yogo for commens. Insiue for Economic Theory II, Humbold Universiy Berlin and Collaboraive Research Cener 649: Economic Risk and Research Training Group Inerdependencies in he Regulaion of Markes. mazelisf@hu-berlin.de 1

3 1 Inroducion Moneary policy makers have been faced wih a reduced abiliy o lower policy raes due o he Zero Lower bound (ZLB). A he same ime, a regulaory overhaul is underway ha is aimed a sabilizing he financial secor. One focus of regulaion has been on he shadow banking secor 1, which has seen a reducion in credi inermediaion by 5% since he financial crisis (see Figure 9 in Appendix C). The regulaory communiy is likely o regulae he financial sysem in a way ha will make i less likely ha shadow banks will play a crucial role going forward (Claessens e al., 212). This paper analyzes which shadow banking regulaions are mos helpful a escaping he ZLB. In his paper, I argue ha a recession a he ZLB is milder and shorer lasing if he credi sysem is less bank based. This argumen is based on he empirical observaion ha banks decrease lending in response o moneary ighening, while non-bank financial insiuions (NBFI) increase lending. A moneary DSGE model wih differen financial inermediaries is able o replicae and explain hese resuls. For banks, he lending channel becomes operaional: moneary ighening resuls in an ouflow of loanable funds, leading commercial banks o reduce lending. Shadow banks are used by commercial banks o circumven capial resricions and increase lending. Households subsiue savings ou of bank deposis and ino higher yielding liabiliies of invesmen funds 2, which will increase lending. 3 I show ha during a ZLB environmen he bank lending channel is operaional, because he lower bound on moneary policy prohibis shor erm raes from falling o he level ha would be chosen wih unconsrained moneary policy. The mechanics of he ZLB herefore resemble a moneary policy ighening: Households prefer higher yielding asses o deposis, which acivaes he bank lending channel. If he financial secor can subsiue ino non-deposi funding, he bank lending channel is weakened and credi ighening is dampened. I ake a sandard moneary DSGE model and embed a financial secor ha is able o replicae key empirical impulse response funcions and aggregae business cycle saisics. I conduc counerfacual analyses in which shadow banks are eliminaed from he model. Since he fundamenals of he real economy are no affeced by he configuraion of he financial sysem, credi demand from he real secor says 1 Shadow banks are ABS Issuers, Financing Companies, Funding Corporaions and Securiy Brokers and Dealers. Their fixed income privae credi inermediaion, which is defined as loans, bonds and commercial paper, oaled abou 35% of all credi o he economy before he 28 financial crisis. This group s common characerisic is ha hey occupy a cenral place in he inernal funcioning of financial markes beween oher financial insiuions. Households ypically do no fund shadow banks direcly. 2 Invesmen funds are muual funds and money marke funds. Alhough less visible han commercial banks, before he financial crisis hese insiuions channeled abou 25% of privae credi o he real secor, and hey have grown since hen. Invesmen funds are invesmen vehicles direcly accessible o households and herefore feaure in household savings decisions. 3 Oher secors ha hold large credi volumes are insurance and pension funds. These insiuions fulfil differen economic funcions compared o pure lenders and would complicae he analysis, and herefore are no considered in his paper. 2

4 consan and will eiher be filled by commercial bank credi or invesmen fund credi. This discussion is crucial for regions currenly assessing differen regulaory sysems, as for example in he European Union, where he Capial Markes Union proposal suggess a move away from a bank-dependen financial sysem o a more capial markes based sysem. I conribue o he exising lieraure in he following hree ways: i) by explaining and replicaing he empirical behavior of NBFI o moneary policy in a moneary DSGE model; ii) by likening he behavior of economies a he ZLB o a response o moneary ighening; and iii) by analyzing he effecs of financial regulaions ha are mos helpful in escaping he ZLB on nominal ineres raes. To do so, I develop a search and maching mechanism ha allows households o make invesmen choices beween deb and equiy in a linear approximaion. There are a number of papers focusing on differen aspecs of shadow banking. Meeks e al. (214) analyze financial sabiliy and consider shadow banks as offbalance shee vehicles of commercial banks o unload risky loans. Verona e al. (213) sudy adverse effecs of excessively easy moneary policy and undersand shadow banks as financial inermediaries specializing in less risky loans akin o bond issuance by invesmen banks. Moreira and Savov (214) analyze he way in which shadow bank liabiliy liquidiy characerisics change over he business cycle. Goodhar e al. (212) sudy differen regulaory regimes o sop fire sales by shadow banks and ake he opposie view o Verona e al., considering shadow banks o be less risk averse, bu sill funded by he commercial banking secor, comparable o off-balance shee vehicles as in Meeks e al. Gerler e al. (216) focus on he role of wholesale banking in ransmiing crises o he real secor. I do no look a crisis periods and he accompanying effecs of fire sales, bankrupcy and regime ransiion. Insead, I focus on business cycle consequences of differen financial sysem configuraions afer hey have been implemened. In he nex secion, I describe he model wih hree ypes of inermediaries and he incorporaion of a savings decision by households. Secion 3 conains he model analysis, including calibraion and Bayesian esimaion, impulse response funcions o moneary policy shocks and business cycle effecs of eliminaing shadow banking. Secion 4 conains he ZLB analysis and reacion of he economy under differen financial secor configuraions, as well as he comparison of a demand shock a he ZLB o a moneary ighening. Secion 5 concludes. Relaed Lieraure This paper conribues o four differen srands of he lieraure. Firs, he paper relaes o he credi channel of moneary policy. The credi channel posis ha following moneary ighening he amoun of credi in an economy is reduced, which amplifies radiional ineres rae and asse price channels. 4 This channel is spli up in he balance shee channel and he bank lending channel. 5 The laer has ofen been 4 For a simple exposiion in he IS/LM framework, see Bernanke and Blinder (1988). 5 See Bernanke and Gerler (1995). The balance shee channel is underlying he financial acceleraor as developed in Bernanke e al. (1999) 3

5 challenged in ligh of banks abiliies o subsiue o non-deposi funding. 6 However, here is a large empirical lieraure ha finds evidence for he bank lending channel. 7 This paper inroduces a mechanism ha allows he financial secor o subsiue ino oher sources of funding and herefore decrease he effeciveness of he bank lending channel. The second srand of he lieraure analyzes moneary policy effeciveness. Over he pas several decades unexpeced moneary policy shocks appear o have had less and less of an influence on he real economy. 8 This is someimes explained by developmens in capial and financial markes. 9 This paper adds o he undersanding of how he financial marke srucure, especially is funding via savers, influences he effeciveness of moneary policy. Third, he paper adds o he undersanding of economies ha are consrained by a ZLB. Alhough he heoreical idea has exised for some ime 1, empirical sudies were limied o he Japanese experience. Since he financial crisis of 28, several sudies have focused on how an economy can escape he ZLB via fiscal policy or unconvenional moneary policy. 11 This paper insead focuses on how he overall composiion of he financial secor faciliaes resilience o he negaive consequences of he ZLB. Lasly, he heoreical mechanism developed in his paper is relaed o he search and maching lieraure. The iniial developmen focused on explaining he dynamics of he labor marke and replicaing key saisics. 12 I has since found applicaions o oher markes, including money and credi relaionships. 13 Following Wasmer and Weil (24), I model funding marke fricions analogously o hose on he labor marke because of heir comparable characerisics of moral hazard, heerogeneiy and specificiy. In conras o Wasmer and Weil, in my model he amoun of deposis changes endogenously. 6 Romer and Romer (199) argue ha bank loan supply is insulaed from moneary policy if banks can fricionlessly find non-deposiory funding. 7 Early suppor from aggregae daa comes from Kashyap e al. (1993). Idenificaion issues, however, necessiae more deailed daa, which were advanced by Kashyap and Sein (1995). 8 For an empirical exploraion, see e.g., Primiceri (25) and Boivin and Giannoni (26). For a srucural explanaion, see Jusiniano and Primiceri (28). 9 See Jermann and Quadrini (26) and Dynan e al. (26) as well as a criique by Haan and Serk (211). 1 See Eggersson and Woodford (23) for a heoreical reamen before he US experience. 11 Chrisiano e al. (211) explain why governmen spending a he ZLB can generally be larger han 1, while Alberini and Poirier (215) and Chrisiano e al. (216) show poenially expansionary effecs of unemploymen benefis. Gambacora e al. (214) explore he effeciveness of unconvenional moneary policy. 12 The seminal paper is Morensen and Pissarides (1994). 13 See den Haan e al. (23) and Wasmer and Weil (24) for early conribuions and Gu e al. (216) and Beaubrun-Dian and Tripier (215) for curren applicaions. 4

6 2 The baseline model economy Alhough he financial secor has been incorporaed ino DSGE models recenly, i is sill largely reaed as a relaively homogeneous eniy. However, empirical sudies indicae ha differen financial insiuions reac differenly o economic shocks: In Mazelis (216), I find ha wo ypes of NBFI, shadow banks and invesmen funds, increase lending afer moneary ighening, while banks decrease lending (see Figure 1). FFR Commercial Banks Invesmen Funds Shadow Banks Figure 1: Responses of inermediaries o a conracionary moneary policy shock. Source: Mazelis (216). Noe: Empirical impulse responses of he federal funds rae and credi by commercial banks, invesmen funds and shadow banks o an unanicipaed 1 basis poin increase in he federal funds rae. Daa for he laer hree are from he Financial Accouns of he Unied Saes, 1984I:26IV. Commercial banks are US Deposiory Insiuions and Credi Unions. Shadow banks are ABS Issuers, Securiy Brokers and Dealers, Financing Companies and Funding Corporaions. Invesmen funds are Muual Funds and Money Marke Funds. As a measure of credi I include loans, bonds, and commercial paper. Idenificaion of he shock follows he recursiveness assumpion of Chrisiano e al. (1999) wih slow moving variables ordered before he shock and credi afer he shock. The horizonal axis repors quarers since he shock. The verical axis repors percenage deviaions from he unshocked pah. Shaded regions are 32nd-68h and 5h-95h perceniles of 1 draws. All variable responses are in Figure 1 in Appendix C. I follow he call by Woodford (21) for a framework for macroeconomic analysis in which inermediaion plays a crucial role and [...] which also akes accoun of he fac ha he U.S. financial secor is now largely marke-based. I employ a moneary DSGE model wih sluggish price seing o generae nominal fricions, as well as financial fricions. The srucure of he shadow banking secor and is relaionship o he res of he financial secor is comparable o Meeks e al. (214) and Gerler e al. (216). Deb and equiy financing are modeled using wo differen ypes of fricions. Deb financing via he moral hazard problem as in Gerler and Kiyoaki (21) and Gerler and Karadi (211) guaranees ha as long as he inermediary 5

7 does no exceed a maximum amoun of leverage per inermediary value, crediors are indifferen owards he absolue amoun of deb ha hey hold. Wihou explicily modeling i, his can be undersood as deposi insurance for commercial banks and pledged, or asse backed, deb for shadow banks. Equiy financing is risky. Since equiy invesors paricipae in he sae-coningen reurns of he inermediary, households are only willing o hold equiy claims ha have an underlying reurns profile ha fis ino he individual household s porfolio. An equiy reurn ha is higher han he ineres rae on deb capures his riskiness. Alhough no modeled explicily, his heerogeneiy on he micro level is capured via a search and maching mechanism: only a fracion of households agree o he erms of he poenial inermediaries ha hey mee on he equiy funding marke. This allows me o solve he savings decision of households via a linear approximaion. Borrowers Goods Producers Inermediaries Commercial Banks Savers Households Physical Capial Loans (Banks) Loans (Shadow Banks) Loans (Funds) Shadow Banks CP Loans CP Ne Worh Loans CP Deposis Ne Worh Invesmen Funds CP Loans Fund Shares Deposis Fund Shares Figure 2: Balance shees of key agens in he economy. Noe: In addiion, he economy is populaed by capial producers and monopolisically compeiive reailers. A cenral bank is he source of moneary disurbances. CP = Commercial Paper. In addiion o he five agens shown in Figure 2, he economy is populaed by capial producers and monopolisically compeiive reailers. A cenral bank conducing moneary policy is he source of moneary disurbances and complees he model. 2.1 Households A coninuum of households of measure one exiss ha consume, save in a porfolio of asses and supply labor. They maximize discouned lifeime uiliy ( ) [ max E β i ln(c hc 1 ) χ ] {C,L,D,N IF } 1 + ϕ L1+ϕ = = i= subjec o he sequence of period budge consrains C + D e + N IF = W L + Π + R D 1 e + R IF N 1. IF Each uni of labor L earns he real wage W. Π are profis from ownership of capial producers, reailers and financial inermediaries. β is he ime-varying 6

8 discoun facor, h is he habi parameer, χ is he relaive uiliy weigh of labor and ϕ is he inverse Frisch elasiciy of labor supply. The asse porfolio consiss of deposis in commercial banks, D, and shares in invesmen funds, N IF. On he micro level, when a household wans o inves ino shares, i eners he funding marke and randomly mees a poenial invesmen fund. If he invesmen fund is a good fi regarding individual porfolio characerisics, hey inves and form a mach. On he macro level, his behavior is approximaed by a search and maching mechanism. We only observe a fracion f of searching households esablish a mach. The endof-period deposis ha remain in he porfolio afer invesmen ino fund shares are hen D e = D (1 f ). The fracion f is endogenously deermined as explained in Secion Invesmen funds pay a sae-coningen ineres rae R IF, which is above he risk-less real reurn R ha banks pay on deposis. A fracion θ IF of households wihdraws heir exising fund invesmens every period, resuling in a law of moion for fund shareholdings: N IF = θ IF N IF 1ξ IF + f D. (1) Reinvesed fund shares migh be affeced by ξ IF, an auoregressive shock process of order one and mean 1. Wih ϱ denoing marginal uiliy of consumpion and µ denoing he addiional value of being invesed in fund shares, he firs order condiions are given by Consumpion C : 1 β +1 h ϱ = E. C hc 1 C +1 hc (2) Labor L : χl ϕ = ϱ W. (3) Deposis D : ϱ = (1 f )E β +1 R +1 ϱ +1 + f (µ + ϱ ). (4) Fund Shares N IF : µ + ϱ = E β +1 { R IF +1 ϱ +1 + µ +1 θ IF ξ IF +1}. (5) The firs order condiions for consumpion and labor are sandard. Equaion (4) reduces o he commonly known Euler condiion in he case ha fund invesmens do no exis or have no addiional value 14, i.e., he household increases savings unil he marginal uiliy of consumpion oday equals he discouned expeced marginal uiliy of consumpion omorrow. If households can inves in fund shares, bu heir abiliy o find a mach is consrained (i.e., f < 1), being invesed in an invesmen fund is valuable (i.e., µ > ). The household herefore increases savings unil he marginal uiliy of consumpion oday equals he probabiliy of consuming omorrow (1 f ) imes is value (he discouned expeced marginal uiliy of consumpion omorrow) plus he probabiliy of invesing in fund shares f imes ha value. The value of invesing in fund { shares is given by Equaion (5). The righ-hand side can be rewrien o yield E β +1 r IF +1 ϱ +1 + (1 θ IF )ϱ +1 + θ IF (ϱ +1 + µ +1 ) }. The firs erm denoes he per period ne reurn r+1 IF from fund share invesmens ha every invesing household receives. The second erm is he fracion of households ha redeem heir fund shares and use hem for curren period consumpion. A fracion θ IF of households says invesed in fund shares and will reap he value of being invesed one period hence, expressed in he las erm. 14 Iff µ =, Equaion (4) holds for all f. 7

9 2.2 Financial Inermediaries There are hree ypes of inermediaries: Commercial banks, invesmen funds and shadow banks. Commercial banks finance he real secor direcly via loans and buy shadow bank commercial paper. Invesmen funds finance loans o he real secor and commercial paper in shadow banks via fund shares, which hey sell o households. They are no able o leverage heir operaions wih deb. Shadow banks use heir funding o exend loans o he real secor Commercial Banks There are infiniely many commercial banks in he economy, which are operaed by members of households. Each commercial bank can make loans S CB o he real secor ha maure in one period and yield a reurn R+1. K Every commercial bank can also exend credi o he shadow banking secor, which is called commercial paper. Commercial paper M CB is differen from regular loans, because i denoes a claim on a pool of loans managed by he shadow bank and yields a reurn R+1 MCB. The commercial bank funds hese claims via ne worh N CB and deposis D ha i receives from oher households (excluding he household ha i is managed by). The balance shee of a commercial bank is hen Q S CB + M CB = N CB + D (6) where Q denoes he price of physical capial. The commercial bank accumulaes earnings ne of he ineres R ha i pays ou o deposiors one period hence: N CB = R K +1Q S CB + R MCB +1 M CB R +1 D. (7) Each commercial bank has a finie life ime and exis he marke wih a probabiliy θ CB each period. Once he commercial bank exis, i pays ou accumulaed lifeime earnings o he household whose member was is manager. The commercial bank herefore maximizes is expeced erminal ne worh V CB by picking is loan porfolio and funding according o V CB = max {S CB,M CB,D } = ( τ ) E β i τ= i= (1 θ CB )θ τ CBΛ,+τ N CB +τ, (8) where he sochasic discoun facor of he household is given by he marginal rae of subsiuion beween consumpion oday and omorrow Λ,+1 and he discoun facor β. Since deposis only pay he risk free rae, a commercial bank has an incenive o keep leveraging up as long as i earns more han R on is credi claims. To moivae leverage endogenously, I inroduce he incenive consrain by Gerler and Karadi (211) (GK11 from here on): Every period, a commercial bank can diver a fracion λ CB of is credi claims, which leads o he erminaion of he commercial bank. Since in such a case deposiors would lose heir claims on he commercial bank, hey force he commercial bank o limi is leverage in such a way ha moivaes he commercial bank o coninue operaions. A commercial bank is required o always 8

10 mainain a value from coninuing operaions ha is a leas as high as he value i would gain from defauling: V CB λ CB [Q S CB + (1 λ ABS )M CB ]. (9) A commercial bank can diver a larger fracion of is real secor loans, which are non-sandardized, han of he commercial paper. Because commercial paper is a claim on a broad pool of loans, is sandardizaion makes i more pledgeable. This is capured in he facor (1 λ ABS ). As λ ABS approaches 1, a commercial bank can reduce is funding consrain by shifing from ourigh lending o commercial paper, hereby evading leverage resricions. This capures he regulaory arbirage moive of off-balance shee vehicles. The soluion o he commercial bank s problem is derived in Appendix A.1 and yields he balance shee relaion Q S CB + M CB (1 λ ABS ) = N CB φ CB (1) wih endogenous leverage φ CB. Since a consan fracion θ CB of commercial banks exi each period, he remaining commercial banks have a ne worh of N CB e = θ CB (R K Q 1 S 1 CB + R MCB M CB 1 R D 1 ). (11) To make up for he ouflow, households esablish new commercial banks according o Nn CB = ω CB (Q S 1 CB + M 1) CB (12) wih ω CB calibraed o pin down he seady sae. The law of moion for commercial bank ne worh is he combinaion of boh exising and new ne worh N CB = Ne CB ξ CB + Nn CB. Exising commercial bank ne worh may be affeced by ξ CB, an auoregressive shock process of order one and mean Invesmen Funds In addiion o commercial bank deposis, households may save in fund shares. Fund shares offer higher reurns on average in order o arac invesmens, bu are saeconingen, since hey are equiy insrumens. Infiniely many invesmen funds offer fund shares ha differ on he micro level wih regards o characerisics like invesmen syle and fund managemen. Similarly, individual household preferences differ on he micro level wih regard o he profile of an invesmen fund and individual porfolio preferences. Because of hese idiosyncraic differences, households need o find a suiable fund, which akes ime. Individual households and invesmen funds mee on he funding marke a random and evaluae he poenial for a mach in isolaion. I absrac from he mechanics on he micro level and approximae he behavior on he macro level via search and maching: in aggregae a fracion q of all invesmen funds searching for funding will find an invesing household. In order o paricipae in he funding marke, invesmen funds need o adverise heir operaions a a cos κ per adverisemen v. Afer forming a mach, an invesmen fund 9

11 is able o inves ino eiher loans o he real secor S IF or he commercial paper of shadow banks M IF. In conras o commercial banks, invesmen funds do no face he incenive consrain problem, since hey do no leverage heir operaions wih deb or deposis. They lend ou all acquired funding eiher o shadow banks or o he real economy. Given heir funding, hey maximize reurns subjec o consrains ha prohibi hem from invesing more han a share ψ IF of asses ino commercial paper. Since commercial paper from shadow banks pays a higher reurn han loans o he real secor (see Equaion (23)), invesmen funds generally inves ino commercial paper up o heir consrain ψ IF. Each period, invesmen funds pay ou a reurn R IF o heir invesing household. Some households will wan o wihdraw funding for consumpion or alernaive savings, while a fracion θ IF keeps heir exising fund shares. The value of an invesmen fund ha has formed a mach is V IF,M = R IF + ψ IF R MIF + (1 ψ IF )R K + θ IF E β +1 Λ,+1 V IF,M +1, (13) where R MIF is he reurn on commercial paper holdings of invesmen funds. Invesmen funds searching for funding have a value V IF,S = κ + q E β +1 Λ,+1 V IF,M +1. (14) Since operaing an esablished invesmen fund is profiable, he value of operaing an invesmen fund searching for funding may generally be profiable if he second erm in Equaion (14) is larger han he search cos κ. Addiional poenial invesmen funds searching for funding will herefore ener he funding marke, which depresses he average fund filling rae q, unil he value of a searching invesmen fund is zero. A Euler condiion for he number of fund adverisemens can be derived: κ q = E β +1 Λ,+1 { R IF + ψ IF R MIF + (1 ψ IF )R K + κ θ IF q +1 }. (15) New fund adverisemens are posed unil he cos of esablishing an invesmen fund is equal o he reurn, which consiss of he difference in ineres income and expenses, as well as he value from no having o look for funding in he nex period. The probabiliy of finding a mach is he number of realized maches m per adverisemen 15, q = m v. (16) The number of maches is deermined by he number of fund adverisemens as well as he amouns households wan o save. Since invesmen funds offer a higher reurn han deposis pay, households always prefer o hold fund shares. 16 The number 15 The rae a which households find a suiable invesmen is he invesmen finding rae f = m /D. 16 The invesmen fund reurn is solved via Nash Bargaining and is derived in Appendix A.4. 1

12 of maches herefore rises wih he amoun of household deposis and is deermined via a Cobb-Douglas maching funcion wih maching efficiency s and maching elasiciy ξ Shadow Banks m = sd ξ v 1 ξ (17) Shadow banks are financial inermediaries ha channel funding from commercial banks and invesmen funds o he real secor. Commercial banks inves ino shadow banks via commercial paper M CB, which is sandardized and herefore more pledgeable o he commercial bank crediors. Invesmen funds inves ino he commercial paper of shadow banks M IF because hey offer a high reurn. Accumulaed earnings in ne worh N SB reain he firs loss of securiized asses. The amoun of real secor lending S SB is Q S SB = M CB + M IF + N SB. (18) Since hey are leveraged, shadow banks maximize erminal expeced ne worh by choosing lending and funding sources according o ( τ ) V SB = max E β i (1 θ SB )θsbλ τ,+τ N+τ. SB (19) {S SB,M CB,M IF } = τ= Reained earnings N SB +1 in a shadow bank are made up of he ineres rae difference ha hey make on loans and wha hey pay on commercial paper by commercial banks and invesmen funds: N SB = R K Q S SB i= R MIF M IF R MCB M CB. (2) As in Meeks e al. (214), shadow banks srucure some of heir liabiliies o be exra safe, i.e., hey pool heir loans and aribue he safes reurns o cerain crediors. These crediors are commercial banks, which need pledgeable securiies o circumven heir regulaory capial consrains. Only a fracion ψ CB of all loans ha shadow banks gran mee his sandard. The amoun of loans ha can be financed via commercial paper held by commercial banks is herefore M CB ψ CB Q S SB. (21) The soluion o he shadow banks problem is derived in Appendix A.2 and yields he balance shee relaion Q S SB = N SB + M IF. (22) 1 ψcb Since some loans remain unsecuriized and non-pledgeable, a porion of he shadow bank balance shees can no be funded by commercial bank holdings of commercial paper. Demand by invesmen funds for commercial paper herefore increases he lending operaions of shadow banks. In order o incenivize invesmen 11

13 funds o hold commercial paper raher han gran loans hemselves, shadow banks share he profi hey receive from addiional lending via Nash bargaining according o R MIF = R K + ζ IF ψ CB 1 ψ CB (RK R MCB ), (23) where ζ IF is he bargaining power of he invesmen fund. Jus like commercial banks and invesmen funds, a consan fracion θ SB of shadow banks exi each period. The remaining shadow banks have a ne worh of N SB e = θ SB (R K Q S SB R MIF M IF R MCB M CB ). (24) To make up for he ouflow, new shadow banks are esablished according o N SB n = ω SB Q S SB 1 (25) wih ω SB calibraed o pin down he seady sae. The law of moion for shadow bank ne worh is he combinaion of boh exising and new ne worh N SB = Ne SB ξ SB + Nn SB. Exising shadow bank ne worh may be affeced by ξ SB, an auoregressive shock process of order one and mean Goods Producers The inermediaries are no producive by hemselves and only derive profis from he reurn on loans o goods producers. Perfecly compeiive goods producers manufacure inermediae goods and sell hem o reailers a he relaive inermediae oupu price P m. Afer producion, non-depreciaed capial is sold o capial producers and refurbished. 17 Labor and capial for pas producion are remuneraed and decisions for new producion are aken: The firm maximizes profis by solving ( τ ) β i [ ] max E Λ,+τ Pmτ Y τ + (Q τ δ)ξ {K +1,L } τ K K τ W τ L τ R kτ K τ Q τ 1 = τ= i= wih producion oupu given by Y = A (ξ K K ) α L 1 α (26) where α is he capial share, Q is he real price of capial, δ is he depreciaion rae, W are wages, A is a oal facor produciviy shock and ξ K is a capial qualiy shock. The firs-order condiions are R K Q = P m α Y K + (Q δ)ξ K (27) P m (1 α) Y = W. (28) L Firms pay ou ex pos reurns o capial as ineres paymens, resuling in no profis sae by sae. Since hey pay he same ineres rae R K o all crediors, loans by differen inermediaries are perfec subsiues and do no ener he maximizaion problem of he firm: K +1 = S CB + S IF 17 Capial producer and reailer programs are discussed in Appendix A.3. + S SB. (29) 12

14 2.4 Marke Clearing, Resources and Policy The aggregae resource consrain is given by consumpion, invesmen and adjusmen coss ( ) In + I SS Y = C + I + f (I n + I SS ). (3) I n 1 + I SS Capial evolves according o K +1 = ξ K K + I n, (31) i.e., an auoregressive capial qualiy shock ξ K of order one capures he variabiliy of capial produciviy inheren in fixed capial. Following he lieraure on he imporance of marginal efficiency of invesmen (Jusiniano e al., 21), invesmen specific shocks ι affec he ransformaion of gross invesmen ino ne invesmen. Gross invesmen I n is I n I ι δξ K. (32) Moneary policy is characerized by a Taylor rule. The nominal ineres rae is given by i, wih a seady sae ineres rae of i SS, he seady sae value of oupu given by Y SS, an ineres rae smoohing parameer ρ i, he inflaion coefficien κ π and he oupu gap coefficien κ y : i = i ρ i 1 [ ( ) κy ] 1 ρi Y i SS (π ) κπ ɛ (33) Y SS The exogeneous shock o moneary policy eners he nominal ineres rae as ɛ. The nominal ineres rae has an effec on he economy hrough he Fisher relaion where E π +1 is expeced fuure ne inflaion. 1 + i = R +1 E (1 + π +1 ), (34) 3 Model specificaion and analysis In his secion, I firs pin down he model parameerizaion via calibraion and Bayesian esimaion. Because I wan o assess he model s abiliy o replicae business cycle saisics, I use a Bayesian esimaion insead of minimizing he disance beween empirical and heoreical IRFs as in Chrisiano e al. (25). Disance minimizaion would be possible if empirical IRFs by he differen inermediaries for oher key macroeconomic disurbances were available. A Bayesian esimaion allows a complemenary analysis wihou hese resuls and can be undersood as a cross validaion for my empirical resuls: he model IRFs o moneary disurbances from he esimaed parameers are comparable o he empirical IRFs in Mazelis (216). Nex, I analyze how moneary policy shocks propagae hrough he economy for four differen composiions of he financial sysem. Since only he financial secor is reconfigured, bu fundamenals of he model economy are unaffeced, real secor 13

15 credi demand is unchanged. The baseline case is he financial sysem wih commercial banks, shadow banks and invesmen funds, corresponding o he siuaion before he financial crisis of 28. Since hen, shadow bank lending has declined and been replaced by commercial bank and invesmen fund lending, which is aribuable o consolidaion in he indusry and new regulaions. To show he effecs of differen financial secor composiions, I consider hree cases, one in which shadow bank lending has been aken up by commercial banks, an alernaive in which invesmen funds have aken up he credi demand, and one in which boh secors share previously inermediaed credi by shadow banks. The differen relaive sizes of commercial banks o invesmen funds are due o changes in parameer values. The affeced parameer values are he proporional ransfer o he enering bankers ω CB, he proporional ransfer o he enering shadow bankers ω SB, he fund s survival rae θ IF, he fund adverising cos κ, and he household bargaining power w.r.. funds ζ HH. The model is solved via firs order perurbaion around he deerminisic seady sae. 3.1 Parameerizaion Several newly inroduced parameers are calibraed o pre-crisis seady sae values or direcly follow from heir economic counerpars. Parameers ha govern he sochasic process as well as hose ha are no pinned down by seady sae values and ha do no have a direc economic counerpar are esimaed. Mos of he srucural parameers presen in GK11 are adoped here. The pre-crisis economy includes a fully acive shadow banking secor wih a share of lending of approximaely 35%, while commercial banks len 4%, and invesmen funds len he remaining 25% of credi. The risk-free rae as measured by Shiller (1992) wih updaed values from his websie is 3 percenage poins per year. This ranslaes ino a quarerly risk-free rae of 75 basis poins, i.e., i SS =.75 assuming zero inflaion in seady sae. In models feauring a convenional Euler equaion his implies a higher discoun facor han β =.99, which is used in his calibraion. However, noe ha if he addiional value from being invesed in invesmen funds, µ, is posiive, and if search fricions guaranee ha he finding rae f (, 1), hen over-saving will resul in a risk-free rae ha is lower han β 1. The fracion of commercial bank asses invesed in commercial paper by shadow banks is se a 3%, as indicaed in bank call repor daa repored in Meeks e al. (214). The corresponding fracion for invesmen fund asses is 4% pre-crisis as indicaed by Flows of Funds daa. Remaining model parameers are chosen o imply a spread for he borrowing rae R k R of 79 bp, equal o he bank prime loan rae spread over he 3-monh Treasury Bill rae beween 21 and 24. A spread of 19 bp as proxied by Moody s Seasoned Aaa Corporae Bond Yield is chosen for he commercial paper rae ha shadow banks pay o invesmen funds. I assume ha shadow banks belong o 14

16 Symbol Value Descripion Source Households β.99 Seady sae discoun rae Gerler and Karadi (211) h.815 Habi parameer Gerler and Karadi (211) χ 3.49 Relaive uiliy weigh of labor Gerler and Karadi (211) ϕ.276 Inverse Frisch elasiciy of labor supply Gerler and Karadi (211) Financial Secors i SS.75 Quarerly nominal rae Shiller (1992) ψ CB.3 Fracion of commercial bank asses invesed in commercial paper Meeks e al. (214) ψ IF.4 Fracion of invesmen fund asses invesed in commercial paper Flows of Funds λ ABS 1 Relaive diveribiliy of ABS Seady sae ζ IF.88 Fund bargaining power re shadow banks Seady sae ζ HH.86 Household bargaining power w.r.. funds Seady sae ω CB.15 Proporional ransfer o he enering bankers Seady sae ω SB.4 Proporional ransfer o he enering shadow bankers Seady sae s.32 Maching efficiency Seady sae κ.7 Search cos Seady sae Goods Producers α.33 Effecive capial share Gerler and Karadi (211) δ.25 Depreciaion rae Gerler and Karadi (211) Reail Firms ɛ Elasiciy of subsiuion Gerler and Karadi (211) γ.779 Probabiliy of keeping prices fixed Gerler and Karadi (211) γ p.241 Price indexaion Gerler and Karadi (211) Governmen κ π 1.5 Inflaion coefficien of Taylor rule Gerler and Karadi (211) κ y.125 Oupu gap coefficien of Taylor rule Gerler and Karadi (211) Table 1: Calibraed parameer values. Noe: seady sae refers o parameer values ha direcly follow from assumed seady sae values. The seady sae values are eiher he relaive share of he financial secor or ineres rae differenials. commercial banks and herefore do no pay a higher ineres rae R MCB han R. This resuls in commercial paper held by commercial banks o be pledgable wih a λ ABS = 1, i.e., commercial banks can no diver hese asses. I follows from he seady sae and parameer values ha he bargaining power of invesmen funds visa-vis shadow banks ζ IF is hen.88, since shadow banks need a buyer of remaining loan pools. The fracion of new equiy ha has o be injeced ino commercial bank and shadow bank equiy, respecively, is ω CB =.15 and ω SB =.4. The maching efficiency s, search coss κ and household bargaining power ζ HH follows from he seady sae and parameer values. Table 1 shows he fixed srucural parameer values and heir source. The remaining parameers, including hose governing he shock processes, are esimaed using Bayesian mehods. Commercial banks, invesmen funds and shadow banks are defined as in Mazelis (216): Commercial banks are US Deposiory Insiuions and Credi Unions. Shadow banks are ABS Issuers, Securiy Brokers and Dealers, Financing Companies and Funding Corporaions. Invesmen funds are Muual Funds and Money Marke Funds. As a measure of credi I include loans, bonds, and commercial paper. The macroeconomic ime series underlying he daa for observables are: real GDP, he consumer price index, he federal funds rae, fixed capial, household consumpion, and credi by commercial banks, invesmen funds and shadow banks (see Table 5 in Appendix C for deails on he daa sources). Since he model is expressed in log-deviaions from seady sae, for esimaion purposes 15

17 Prior Poserior Symbol Name Type Mean Sd. Dev. Mean L.B. U.B. Srucural ξ Maching elasiciy Bea λ CB Commercial bank s diverible share Bea θ CB Commercial bank s survival rae Bea θ IF Invesmen fund s survival rae Bea θ SB Shadow banker s survival rae Bea Persisence parameers ρ A TFP Bea ρ i Moneary Policy Bea ρ ξ Capial Qualiy Bea ρ IS Invesmen Efficiency Bea ρ β Demand Bea ρ CB Commercial bank equiy Bea ρ IF Invesmen fund equiy Bea ρ SB Shadow bank equiy Bea Sd dev. e A TFP Inverse Gamma e i Moneary Policy Inverse Gamma e ξ Capial Qualiy Inverse Gamma e IS Invesmen Efficiency Inverse Gamma e β Demand Inverse Gamma e CB Commercial bank equiy Inverse Gamma e IF Invesmen fund equiy Inverse Gamma e SB Shadow bank equiy Inverse Gamma Table 2: Priors and poseriors of esimaed parameers. Noe: L.B. is he lower bound of he 9% highes poserior densiy inerval. U.B. is he upper bound of he 9% highes poserior densiy inerval. I ake he log difference from he one-sided HP filered rend (smoohing parameer is se o 16) for all variables excep inflaion and he federal funds rae, which are depiced in Figure 12 in Appendix C.3. The daa have a quarerly frequency and range from 1984:I o 26:IV. The priors for all persisence parameers are relaively uninformaive Bea disribuions wih a mean of.5 and a sandard deviaion of.2. The priors for he whie noise processes on he innovaions are Inverse Gamma disribuions wih means.1 sandard deviaions of.5. The shock processes are a priori independen. The prior disribuions for he srucural parameers are bea disribuions. The inerval for he maching elasiciy allows all parameers beween and 1. The commercial bank s diverible share λ CB is cenered on he GK11 value of.381 and bound from below and bound from above o limi commercial bank leverage. The inervals for survival raes are beween (.5, 1.). I run 2 Mone Carlo Markov Chains wih 1. draws each over he full sample period. Convergence is reached afer abou 2. draws and I drop he firs 5% of esimaed values. Table 2 shows he resuls. The poseriors of he shock processes are informaive (see Appendix C.3). In order o illuminae he dynamics of he maching fricion, I do a robusness analysis of he maching elasiciy ξ in Appendix B. 16

18 3.2 Response o a moneary policy shock Figure 3 shows impulse response funcions for key variables afer unexpeced moneary policy ighening for he case of i) he original GK11 economy, ii) he baseline case wih invesmen funds and shadow banks, iii) he loans previously held by shadow banks now inermediaed by commercial banks (bank dependen), and iv) he shadow bank loans inermediaed by funds (fund dependen). The hird case corresponds o commercial banks graning 75% of all loans o he real economy, while he las case has commercial banks inermediaing a oal of 4% of credi. Invesmen funds inermediae he remaining share in he laer wo cases. Firs, consider he original GK11 economy. Afer an unexpeced moneary ighening of abou 1 basis poins in he firs period, ineres raes on commercial bank deposis increase o encourage deposiors o keep heir savings wih commercial banks insead of shifing hem ino oher asses. Because households have a higher incenive o save, consumpion drops. The reducion in consumpion demand ranslaes ino lower oupu and a reducion in he demand for physical capial by firms, which also lowers he price for physical capial. Lower oupu and capial prices iniially diminish he reurn on capial for he firm, see Equaion (27). Since firms pass his reurn on as he borrowing cos o he inermediary, exising commercial bank profis are hi. In he second period, he borrowing rae increases, because he price for physical capial slowly rises from is iniial low. Since he risk-free rae does no increase by as much as he borrowing rae, he exernal finance premium (EFP) rises. Equaion (A.2) increases as he EFP rises, indicaing gains from expanding asses for commercial banks. This means ha he reducion in lending is no jus due o he balance shee channel, which would necessiae a drop in credi demand. Banks are unable o quickly raise equiy and soliciing more deposis from households would cu ino heir margin. Credi o he real secor herefore drops. The baseline case feaures shadow banks and invesmen funds. Afer a moneary policy increase, he iniial reacion in he economy is he same. However, commercial banks now have he abiliy o leverage up on heir exising ne wealh by increasing heir invesmens ino shadow banks, which lend on heir behalf. A he same ime, commercial banks face compeiion from invesmen funds, which increase he fund rae more aggressively han commercial banks increase he deposi rae. Households herefore subsiue away from commercial bank deposis and ino invesmen fund shares, which is consisen wih empirical findings (Drechsler e al., 216). Since many previously crediworhy borrowers were pushed ou of he marke, invesmen fund and shadow bank loans now replace some of he los commercial bank credi. The bank lending channel is herefore reduced, because he financial secor subsiues away from bank deposis and ino oher funding opions. This has a dampening effec on he fall in physical capial, which is reduced wo hirds less compared o he GK11 economy wih only commercial banks. The effec of he miigaed credi crunch is a less pronounced recession. Two addiional cases describe wha happens afer eliminaion of he shadow banking sysem. If he credi previously inermediaed by shadow banks is now graned by commercial banks (he bank dependen scenario), here is no room for ourigh 17

19 regulaory capial arbirage by commercial banks anymore. Commercial banks herefore cu back on credi afer moneary policy ighening, opening up he possibiliy for invesmen funds o fill he excess credi demand. Invesmen funds do so by raising funding from households. Alhough invesmen funds increase lending by more han 3%, he decrease in commercial bank borrowing is hardly offse, resuling in a decrease in physical capial ha is abou wice as large as in he baseline case. If insead invesmen funds inermediae he credi ha was previously held by shadow banks (he fund dependen scenario), capial reducion is comparable o he bank dependen scenario. The behavior is he resul of differen mechanisms, however. Shadow banks allow commercial banks o circumven capial requiremens and raise more deposis han households would be willing o lend o commercial banks hemselves. In he case of large invesmen funds insead of shadow banks, any losses are passed on o he households owning he fund shares. New invesmens in invesmen funds sill ake place as households decrease consumpion and allocae heir resources o savings, especially fund shares. % Dev. from s.s GDP Consumpion Bank deposis Aggregae lending % Dev. from s.s. 1.5 Risk-free rae Borrowing rae EFP Price of capial % Dev. from s.s Bank loans Fund loans Shadow bank loans Expeced fund rae GK Baseline Bank dependen Fund dependen Figure 3: Model IRFs o moneary policy ighening of 1 basis poins. Noe: The black, solid lines repor he IRFs from he model wihou NBFI, which is he basic GK model. The blue, solid lines repor IRFs from he full model including NBFI. The green, doed lines wih cubes are responses for he baseline model wihou shadow banks where commercial banks assume he excess credi demand. The orange, dashed lines wih diamonds are responses for he baseline model wihou shadow banks where funds assume he excess credi demand. The horizonal axis repors quarers since he shock. The verical axis repors percenage deviaions from he seady sae (excep for he ineres raes and he EFP, which are repored in percenage poins). 18

20 The behavior of shadow bank lending following a moneary policy ighening is consisen wih he lieraure. A moneary ighening in he model induces a drop in commercial bank lending. In he BVAR in Mazelis (216), commercial bank lending conracs in a hump shaped fashion over six years. The increase in invesmen fund and shadow bank loans in he empirical resuls are mirrored in he model reacion. A resuling negaive.6% in GDP in he BVAR is exacly reached in he model. The difference is in iming. While he model reacs wihin he firs couple of periods, he empirical IRFs have a longer ransmission period. For he sake of racabiliy, I refrain from using any modeling devices ha replicae empirical IRFs more closely. Pescaori and Sole (216), Nelson e al. (215) and Igan e al. (213) all show empirically ha some shadow banks increase lending afer moneary policy ighening, while commercial banks reduce lending. Haan and Serk (211) show ha boh morgages and consumpion credi by shadow banks increase following an increase in he moneary policy rae. Finally, Alunbas e al. (29) show ha European banks wih more securiizaion aciviies reduce heir lending by less han non-securiizing banks afer moneary ighening. European universal banks house boh commercial banking and shadow banking aciviies wihin he same group srucure. This finding is in line wih undersanding securiizing banks o be less affeced by moneary shocks because heir shadow banking operaions are larger, which insulaes aggregae group lending behavior by increasing shadow bank lending following moneary policy ighening. 3.3 Business Cycle Effecs The benchmark economy wih shadow banks compares well o second momens of some key variables in he daa. Table 3 shows a close fi for GDP and inermediary credi sandard deviaions. Fixed capial is no as volaile as in he daa, which migh be due o labor being fully flexible and absorbing volailiy in he producion process. This migh be fixed wih model feaures like variable capial uilizaion and eiher monopolisically compeiive labor unions or a search and maching process beween firms and workers. If shadow banks are eliminaed, he volailiy of aggregae variables necessarily decreases because he sochasic process affecing shadow bank equiy is eliminaed. The hree counerfacual scenarios can herefore be compared among each oher bu no o he baseline scenario. GDP and consumpion are more volaile in fundheavy economies because households earn a sae-coningen reurn on fund shares insead of a non-coningen reurn on commercial bank deposis. Alhough his makes consumpion smoohing more difficul, i insulaes he financial secor from assuming losses. Passing on variable profis may increase financial sabiliy by having he ulimae equiy holders help absorb fundamenal shocks. Apar from a change in second momens, variable means may also change. 18 Since he fundamenals in he economy are no affeced by he composiion of he 18 Deerminisic seady saes are sudied, which ignore precauionary savings, o guaranee comparabiliy among model varians. 19

21 Shadow bank loans held by Variable Daa Baseline Banks Spli 5/5 Funds GDP Inflaion Consumpion Physical capial Commercial bank loans Invesmen fund loans Shadow bank loans Table 3: Second momens of daa and model varians (all numbers in %). Noe: Second momens for he daa are calculaed from cyclical variaions around he onesided HP filered log daa from 1984:I o 26:IV. Second momens for he model varians are based on shock processes as esimaed in Secion 3.1. financial sysem, real economy variable means are unchanged. Insead, funding of he financial secor moves ino he spoligh. In a more bank-dependen economy, commercial banks have o increase heir deposi base by abou 25%. This benefis households by increasing heir oal reurn from deposis by abou 35%. Wihou shadow banks, however, regulaory arbirage is no possible and commercial banks have o increase heir equiy holdings by abou 8%. This increase in equiy is arguably beer for he sabiliy of he financial secor, bu i does beg he quesion wheher commercial banks would be able o raise he required capial following a financial crisis. In he case ha he economy becomes more fund-dependen, commercial bank deposis diminish. Insead, fund share holdings are increased by abou 4%, while commercial bank equiy says he same. This increases oal fund reurns o households, while decreasing oal reurns o deposis. The ne resul is a slighly higher oal reurn for households from financial asses compared o he baseline case, and a 5 percenage poin increase above he bank-dependen scenario. The reason for his is ha fund reurns are sochasic and herefore have o remunerae he invesor for uncerainy. 4 Shadow bank regulaion a he zero lower bound Before he financial crisis, he shadow banking sysem conribued abou 35% of credi o he real economy. This share has dropped significanly since 27 (see Figure 9 in Appendix C). The shadow banking sysem has been he explici focus of financial regulaion in many counries around he world, see Financial Sabiliy Board (213) for an overview. Alhough no consensus has emerged, he dominan principle has been o bring credi inermediaion ou of he shadows. This means ha shadow banks would eiher be differenly regulaed, or ha hey cease o exis and ha he credi demand hey previously inermediaed would be assumed by 2