Central, Traditional and Shadow Banking in the Multiple Deposit Creation Scheme

Abstract

This paper studies the effect of shadow banks on monetary aggregates, credit to private agents, and inter-financial institution transactions by incorporating shadow banks into a simple multiple deposit creation scheme. The simple scheme is carefully modified and extended to reflect leverages taken by shadow banks, proprietary transactions by commercial banks and the interest rate-oriented monetary policy operational framework. This paper shows that transactions between commercial and shadow banks can be determined somewhat endogenously although the model is completely deterministic, and as such, interbank transactions can grow enormously while the size of broad money and credit to private agents does not increase much. In this way, shadow banks contribute to the build-up of systemic risk. This paper also discusses policy implications of the findings.