Shadow banks and macroeconomic instability

Abstract

We develop a macroeconomic model in which commercial banks can offload risky loans to a ?shadow' banking sector, and financial intermediaries trade in securitized assets. We analyze the responses of aggregate activity, credit supply and credit spreads to business cycle and financial shocks. We find that: interactions and spillover effects between financial institutions affect credit dynamics||high leverage in the shadow banking system makes the economy excessively vulnerable to aggregate disturbances||and following a financial shock, stabilization policy aimed solely at the securitization markets is relatively ineffective.