Deposit Insurance and the Coexistence of Commercial and Shadow Banks

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Presentation transcript:

Deposit Insurance and the Coexistence of Commercial and Shadow Banks Stephen F. LeRoy and Rish Singhania Discussion: Lamont Black

Main Idea Deposit insurance affects the structure of the financial system Banks vs. shadow banks Deposit insurance affects the price of risky assets Buying vs. selling

The Model Agents choose commercial bank or shadow bank Commercial banks have insured deposits Tradeoff: expected insurance benefit vs. insurance premium High premiums make shadow banks more attractive

Price Distortions Price distortions can indirectly benefit shadow banks Commercial banks and shadow banks trade risky assets Deposit-based premiums banks buy Risk-based premiums banks sell Failing banks overpay for risky assets

Suggestions 1 Add external uninsured debt Partial insurance and wholesale debt Weaken Modigliani-Miller “market discipline” E.g., cost rises with risk in period 2 Add underfunded insurance externality (revenue favorable to commercial banks) Lump sum tax beyond shadow banks?

Suggestions 2 Big shocks The productivity shock is idiosyncratic Add an aggregate shock Add a commercial/shadow bank shock Fire sales Make the risky asset mark-to-market How would these elements interact with deposit insurance?

Directions for Future Research Add liquidity risk in shadow banks Dis-intermediation in good times Re-intermediation in bad times What if shadow banks fail? Explore the technology of FINTECH E.g., capital market funding for loans “fintech charter” (OCC)