Authors: Kinda Hachem and Martin Kuncl
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Staff Reports
The Prudential Toolkit with Shadow Banking
Number 1142
March 2025 Revised March 2025
March 2025 Revised March 2025
JEL classification: D62, E61, G01, G21, G28
Several countries now require banks or money market funds to impose state-contingent costs on short-term creditors to absorb financial stress. We study these requirements as part of the broader prudential toolkit in a model with five key ingredients: banks may face an aggregate stress state with high withdrawals; a fire-sale externality motivates a mix of non-contingent and state-contingent regulation; banks may use shadow technologies to circumvent regulation; parameters of the shadow technologies may be private information; and bailouts may occur. We characterize the optimal policy for various combinations of these ingredients and demonstrate that the threat of shadow activities constrains state-contingent regulation more than noncontingent regulation, especially when imperfect information and limited commitment coexist. The planner triggers shadow activities with positive probability under imperfect information, and shadow activities that deplete resources in the stress state elicit larger bailouts under limited commitment, rendering the requirement of state-contingent costs a weak instrument.
Author Disclosure Statement(s)
Kinda Hachem
The author declares that she has no relevant or material financial interests that relate to the research described in this paper. Prior to circulation, this paper was reviewed in accordance with the Federal Reserve Bank of New York review policy, available at https://www.newyorkfed.org/research/staff_reports/index.html.
Martin Kuncl
The author declares that he has no relevant or material financial interests that relate to the research described in this paper.
The author declares that she has no relevant or material financial interests that relate to the research described in this paper. Prior to circulation, this paper was reviewed in accordance with the Federal Reserve Bank of New York review policy, available at https://www.newyorkfed.org/research/staff_reports/index.html.
Martin Kuncl
The author declares that he has no relevant or material financial interests that relate to the research described in this paper.
Suggested Citation:
Hachem, Kinda, and Martin Kuncl. 2025. “The Prudential Toolkit with Shadow Banking.” Federal Reserve Bank of New York Staff Reports, no. 1142, March. https://doi.org/10.59576/sr.1142
Hachem, Kinda, and Martin Kuncl. 2025. “The Prudential Toolkit with Shadow Banking.” Federal Reserve Bank of New York Staff Reports, no. 1142, March. https://doi.org/10.59576/sr.1142
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