Banking 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.
"Sustainable Shadow Banking."
American Economic Journal: Macroeconomics,
Asymmetric and Private Information; Mechanism Design
Banks; Depository Institutions; Micro Finance Institutions; Mortgages
Financial Institutions and Services: Government Policy and Regulation
Capital Budgeting; Fixed Investment and Inventory Studies; Capacity
Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
Firm Performance: Size, Diversification, and Scope