Presenter: Genevieve Nelson (Danmarks Nationalbank)
In this paper I show that the existence of unregulated financial intermediaries (“shadow banks”) generates overborrowing (relative to the socially optimal level) in competitive equilibrium. This is because borrowers fail to internalize that an additional unit of borrowing, when the financial sector is well functioning, has adverse effects on the credit conditions they will face if a crisis arises. The social planner therefore has a motive to intervene to reduce borrowing in good times so as to limit the severity of a crisis.