This essay discusses the economic case for regulating shadow banking. Focusing on systemic risk, shadow banking is defined as leveraging on collateral to support liquidity promises. Regulating shadow banking is efficient because of the negative externality stemming from systemic risk. However, because uncertainty undermines the precise measurement of systemic risk, quantity regulation is preferable to a Pigovian tax to cope with this externality. This paper argues that regulation should limit the leverage of shadow banking mainly by imposing a minimum haircut regulation on the assets being used as collateral for funding.

Additional Metadata
Keywords Shadow banking, maturity transformation, safe assets, leverage, liquidity, collateral, haircut, externalities, quantity regulation, Pigovian tax, Money Market Mutual Funds, repo, derivatives, central clearing, Qualified Financial Contracts
JEL Financial Crises (jel G01), Pension Funds; Other Private Financial Institutions (jel G23), Government Policy and Regulation (jel G28), Corporation and Securities Law (jel K22), Regulated Industries and Administrative Law (jel K23)
Persistent URL hdl.handle.net/1765/99694
Series European Corporate Governance Institute (ECGI) - Law Working Paper Series
Note Forthcoming in: Iris H. Chiu & Iain MacNeil (eds.), Research Handbook on Shadow Banking: Legal and Regulatory Aspects, Edward Elgar (2017)
Citation
Pacces, A.M, & Nabilou, H. (2016). The Law and Economics of Shadow Banking (No. 339/2017). Iris H. Chiu & Iain MacNeil (eds.), Research Handbook on Shadow Banking: Legal and Regulatory Aspects, Edward Elgar (2017). Retrieved from http://hdl.handle.net/1765/99694