New York Fed researchers investigate shadow-banking regulation

Editor’s Note:  The Federal Reserve Bank of New York’s Staff Report, Shadow Banking Regulation, by Tobias Adrian and Adam B. Ashcraft is attached below.

From: CentralBanking.com

The Federal Reserve Bank of New York has published a staff report that finds “uneven” progress in achieving a more stable shadow-banking system.

Authors Tobias Adrian and Adam Ashcraft review the rapidly growing literature on shadow banking and provide a “conceptual” framework for its regulation.

Having contributed to the credit boom in the early 2000s, the authors note how shadow banks “collapsed during the financial crisis of 2007–09”. Since that time, regulatory reform efforts have aimed at strengthening the stability of the shadow banking system.

The report focuses on identifying the gap between the optimal and actual regulation of the shadow- banking sector. “To accomplish this, we first outline a framework through which to understand optimal shadow financial intermediation, characterising the asset risk, liquidity, and leverage choice of shadow intermediaries in the presence of appropriately risk-sensitive funding,” write the researchers. “We then highlight frictions which drive a wedge between optimal and actual risk choice, resulting in excessive levels of asset risk as well as maturity and risk transformation.”

The report also reviews the implications of reform efforts for shadow funding sources, including asset-backed commercial paper, triparty repurchase agreements, money market mutual funds and securitisation. “Despite significant efforts by lawmakers, regulators and accountants, we find that progress in achieving a more stable shadow banking system has been uneven,” the report states.

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