Banking Regulation.

• Author: Van Doren, Peter
• Position: Working Papers

"The Limits of Shadow Banks," by Greg Buchak, Gregor Matvos, Tomasz Piskorski, and Amit Seru. October 2018. SSRN #3260434.

Traditional banks accept deposits that are federally insured, issue loans, are members of the Federal Reserve System, and are subject to safety and soundness banking regulations and examinations. Shadow banks, on the other hand, do not accept deposits; they raise money in the capital markets. They originate loans, not to hold in their portfolio, but to securitize and sell to other investors. Among those investors are the government-chartered Federal National Mortgage Association (Fannie Mae) and Federal Home Loan Mortgage Corporation (Freddie Mac), which also receive government subsidies.

The 2010 Dodd-Frank banking reform legislation, passed after the financial crisis in 2008 and the ensuing Great Recession, altered the regulation of traditional banks but not shadow banks. This paper argues that because shadow and traditional banks are partial substitutes for each other, the effects of regulatory reform on traditional banking has shifted some banking activity to the shadow sector, dampening any soundness benefits from Dodd-Frank.

The market for mortgages is segmented. Well-capitalized traditional banks issue so-called jumbo loans (above $484,350, or $726,525 in high-cost home areas) that cannot be sold to Fannie Mae and Freddie Mac. Thus, the traditional banks hold those loans on their balance sheets...