The Macroeconomics of Shadow Banking

We build a macro-finance model of shadow banking: the transformation of risky assets into securities that are money-like in quiet times but become illiquid when uncertainty spikes. Shadow banking economizes on scarce collateral, expanding liquidity provision in booms, boosting asset prices and growth, but also creating fragility. A rise in uncertainty raises shadow-banking spreads, forcing the financial sector to switch to collateral-intensive funding. Shadow banking collapses, liquidity provision shrinks, liquidity premia and discount rates rise, asset prices, investment, and growth fall. The model generates slow recoveries, collateral runs, and flight-to-quality. It sheds light on LSAPs, Operation Twist, and other interventions