Do contractionary monetary policy shocks expand shadow banking?

Abstract

Summary Using VAR models for the USA, we find that a contractionary monetary policy shock has a persistent negative impact on the level of commercial bank assets, but increases the assets of shadow banks and securitization activity. To explain this “waterbed” effect, we propose a standard New Keynesian model featuring both commercial and shadow banks, and we show that the model comes close to explaining the empirical results. Our findings cast doubt on the idea that monetary policy can usefully “get in all the cracks” of the financial sector in a uniform way.

How does monetary policy respond to the dynamics of the shadow banking sector?

“…The empirical evidence presented so far highlights that monetary policy responds to developments in the asset growth of financial intermediaries, such as securities' brokers and dealers and shadow banks. However, some authors like den Haan and Sterk () and Nelson et al () emphasize that monetary policy actions also have an impact on the growth of nonbank mortgage lending as well as on securitization activity.…”

“…Finally, as in Adrian and Shin (, , ), Adrian et al (, ), Berrospide and Edge (), and Nelson et al (), we construct the growth rate of the assets of securities' brokers and dealers and the growth rate of assets of the shadow banking sector. We collect data from the flow of funds accounts of the Board of Governors of the Federal Reserve System.…”

“…On the other hand, they may magnify the transmission of monetary policy if their risk appetite is more sensitive to changes in the interest rate (IMF, ). Indeed, financial intermediaries do not react to monetary policy in the same manner (Nelson, Pinter, & Theodoris, ). Hence, understanding this dynamics is relevant from a policy perspective, as the role of market‐based financial intermediaries (e.g., brokers and dealers and shadow banks) has significantly increased over time.…”

“…In order to reduce the need of new equity issuance, banks more engaged in maturity transformation, with a positive duration gap and relying less on financial derivatives to hedge interest rate risk are also more likely to forgo new lending opprtunities or reduce lending when faced with a monetary policy tightening that negaively impacts on their profits (Flannery, ; van den Heuvel, ). Nelson et al () show that unexpected monetary contractions reduce the asset growth of commercial banks and expand the asset growth of shadow banks—as securitization activity rises, even though the contribution of monetary policy surprises to the overall financial sector asset growth has been small. In the United States, securities' broker and dealers seem to be less responsive to monetary policy than banks, but only money market funds show contrarian responses (Igan, Kabundi, Simone, & Tamirisa, ).…”

Needed but Rejected: How to Implement the Financial Stability Objective into Monetary Policy?

“…As a result of this numerous unconventional tools were targeted specifically at these segments. The economists of the Bank of England (Nelson et al, 2015) warn that firstly, an LATW policy is limited in terms of the degree to which it is able to influence the growth of the balance sheets of financial intermediaries -it is capable to affect primarily the banks -, and secondly, it may bolster the growth of the shadow banking system through its negative impact on the traditional banking system (such as higher funding costs).…”