How Shadow Banking Reshapes the Optimal Mix of Regulation (opens in new tab)

Decisions that are privately optimal often impose externalities on other agents, giving rise to regulations aimed at implementing socially optimal outcomes. In the banking industry, regulations are particularly heavy, plausibly reflecting a view by regulators that the relevant externalities could culminate in financial crises and destabilize the broader economy. Over time, the toolkit for regulating banks and bank-like institutions has expanded, as has banks’ restructuring of activities into ...