AbstractBanking regulation is beneficial because it constrains banks' portfolios to prevent excessive risk taking. But given that regulators usually know less than a bank about its investment opportunities, regulation comes at the cost of foregoing profitable investments. I argue that shadow banking improves welfare because it provides a channel to escape excessive regulation that is asymmetrically more valuable for banks with access to efficient investment opportunities. I propose a novel intervention that improves welfare further by taxing shadow activities, subsidizing regulated activities and allowing banks to self-select into being regulated or not. (JEL D82, G21, G28, G31, G32, L25)
American Economic Journal: Macroeconomics – American Economic Association
Published: Jan 1, 2018
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