How capital regulation and other factors drive the role of shadow banking in funding short-term business credit

• Published in: Journal of banking & finance 2016-08, Vol.69, p.S10-S24
• Main Author: Duca, John V.
• Format: Article
• Language: English
• Subjects: Credit rationing; Economic forecasts; Financial frictions; Regulation; Regulation of financial institutions; Shadow banking; Studies
• ISSN: 0378-4266; 1872-6372
• DOI: 10.1016/j.jbankfin.2015.06.016

•The paper empirically models the shadow bank share of short-term business credit in the U.S.•Several variables are used to track various short- and long-term factors suggested by various strands of literature.•Capital and reserve requirement arbitrage—along with information costs—drive the shadow bank share in the long-run.•Deposit regulation, the economic outlook, event risks, and risk premia drive the shadow bank share in the short-run.•The shadow bank share is vulnerable to short-run liquidity shocks and is pro-cyclical as stressed in recent literature. This paper empirically analyzes how capital regulation, risk, and other factors altered the relative use of shadow banking-funded, short-term business debt since the early 1960s. Results indicate that the share was affected over the long run not only by changing information and reserve requirement costs, but also by shifts in relative regulation of bank versus nonbank credit sources—such as Basel I in 1990 and reregulation in 2010. In the short-run, the shadow bank share rose when deposit interest rate ceilings were binding on traditional banks, the economic outlook improved, or risk premia declined, and fell when event risks arose.