Placing the Czech Shadow Banking Sector under the Light

Abstract

The size of the shadow banking sector (SBS) has more than doubled in the Czech Republic over the last decade. This places a potential burden on policy makers. On the one hand, the SBS complements regular banking by expanding access to credit and investments, enabling better risk sharing and maturity transformation, and supporting market liquidity. On the other hand, SBS activities can put the stability of the financial system at risk and amplify its procyclicality by exacerbating the buildup of leverage and asset price bubbles. We implement a FAVAR model of the Czech economy to determine the impact of macroeconomic factors on the SBS. We find that the SBS: (i) is sensitive to changes in market interest rates and term spread; (ii) exhibits great procyclicality; (iii) can act as a complement to regular banking and satisfy some additional demand for credit. We also define some potential risks of continued growth of the SBS, linked to our empirical evidence.

A prolonged period of low interest rates in Europe: Unintended consequences

“…As discussed earlier, banks can partially relax their credit standards and invest in more profitable but potentially riskier assets (Adrian & Liang, 2018;Adrian & Shin, 2010;Borio & Zhu, 2012;Dell'Ariccia et al, 2017;Gambacorta, 2009;Jiménez et al, 2014;Rajan, 2006). This search for higher yield is also present among nonbank financial institutions (see, for example, Ammer et al, 2018;Hodula, 2019;Lysandrou, 2014). 23…”

“…Less regulated segments are generally more sensitive to market shocks. As such, the combination of highly accommodative monetary policy and more stringent capital regulation may not only stimulate growth of "shadow banking" (Goda et al, 2013;Hodula, 2019;Hodula et al, 2020;Lysandrou, 2014), but also increase demand for nonbank loans in the private nonfinancial sector (Hodula, 2019).…”

“…In addition, they show that the relationship between monetary policy and growth of nonbank financial institutions is level-dependent, with the relationship being positive if interest rates are low. Furthermore, Hodula (2019) demonstrates that the postcrisis monetary policy easing caused massive inflows into investment funds as a result of search for yield induced by persistently low interest rates.…”

“…23 Lysandrou (2014) shows that investors searching for higher-yielding assets in hedge funds before the GFC boosted the supply of these securities, which then significantly amplified the impact of the initial shock and led to the near collapse of the whole financial system. Hodula (2019) shows that monetary policy easing after the GFC caused massive inflows into investment funds as a result of search for yield behavior induced by persistently low interest rates. Ammer et al (2018) explore a specific case of search for yield on foreign investment in riskier US corporate bonds.…”

Risk Premium and Comparison with Damodaran Methodology

“…The financial sector in the Czech Republic has more than doubled in the last decade [ 13 ]. The key for the evaluation of the risk premium is to properly evaluate historical results which allows to implement higher profits in the future.…”