Shadow Banking and the Four Pillars of Traditional Financial Intermediation
Traditional banking is built on four pillars: SME lending, insured deposit taking, access to lender of last resort, and prudential supervision. This paper unveils the logic of the quadrilogy by showing that it emerges naturally as an equilibrium outcome in a game between banks and the government. A key insight is that regulation and public insurance services (LOLR, deposit insurance) are complementary. The model also shows how prudential regulation must adjust to the emergence of shadow banking, and rationalizes structural remedies to counter financial contagion: ring-fencing between regulated and shadow banking and the sharing of liquidity in centralized platforms.
The authors are grateful to Aimé Bierdel, Mathias Dewatripont, Veronica Guerrieri, Frédéric Malherbe, Paul-Henri Moisson, John Moore, Francisco Nadal de Simone, Guillermo Ordonez, Guillaume Plantin, Jeremy Stein, Joseph Stiglitz, John Vickers, four referees, and participants at the Shanghai Frontiers of Macroeconomics conference, LACEA-LAMES Buenos Aires conference, 2019 ASSA meetings, Bocconi, Central Banks of England, France, Luxembourg and Uruguay, Harvard, NY Fed, and ULB for helpful comments. This project has received funding from the European Research Council (ERC) under the European Union’s Horizon 2020 research and innovation programme (grant agreement n° 669217 - ERC MARKLIM). The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.
Emmanuel Farhi & Jean Tirole & Veronica Guerrieri, 2021. "Shadow Banking and the Four Pillars of Traditional Financial Intermediation," The Review of Economic Studies, vol 88(6), pages 2622-2653.