The Shadow Banking System: The Result of Excessive Banking Regulation or a Real Economic Role?

The rise of the shadow banking system (SBS), providing liquidity and credit as a classic bank, raises theoretical questions regarding the rationale behind its apparition. Is it a mere response to banking regulation that would have eroded bank profitability or does it have a distinct economic function? There is empirical evidence that banking regulation has led to some regulatory trade-off and has impacted the size of the SBS, but this system does have a specific economic role of its own. It allows for a better risk diversification due to the theoretical advantages linked to securitization. But the reality of this diversification has empirically been challenged after the 2007-2008 crisis. The economic function of the SBS also relies on the very nature of its liabilities, which offer institutional investors, in search of short-term safe deposits, and who are not entitled to deposit insurance which is reserved to households, a form of deposit insurance through collateralized debt issued by these structures, protection which nevertheless remains subject to variation of the collateral value on financial markets.