Shadow banking, financial stability and economic performance: implications for regulation in emerging economies
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Date
2019
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University of Zululand
Abstract
Shadow banking became a topical issue in advanced economies during and after the global financial crisis of 2007/2008. The importance of the study of the shadow banking sector stems from the need to identify the channels through which it benefits the economy and also channels through which it can become detrimental to economic performance through propagation of systemic risk. Available literature, however, does not provide evidence on the impact of the growth of the shadow banking system on both financial stability and macroeconomic performance in emerging economies. This study contributes to the extant literature on financial innovation by providing evidence on the linkages between the shadow banking sector, economic performance and stability of financial systems across national borders in emerging economies.
The study firstly reviews literature on shadow banking focusing on the channels through which shadow banking impacts the macro-economy, financial stability and monetary policy. Five empirical papers, each with a unique contribution to literature are used to show the impact of shadow banking on various macro-economic and financial variables using a panel of emerging market economies. Firstly, the study employs the Pooled Mean Group technique to estimate a model in which economic growth is a function of shadow banking and other variables. The results show that shadow banking is positively related to economic growth. The second paper analyses the impact of shadow banking on bank risk across national borders within a Global Vector Auto-regressive (GVAR) framework. The findings show increased financial fragility as a result of a negative shock in shadow banking at the global level in the majority of economies under study. Furthermore, the study identifies financial contagion across national borders amongst emerging countries and between emerging countries and advanced economies through the shadow banking sector.
In another paper, the study investigates the relationship between shadow banking and monetary policy using the Panel Vector Auto-regression (PVAR) technique. The findings point to the existence of a negative relationship between the monetary policy rate and shadow bank growth. Contractionary monetary policy results in reduction in shadow bank activity. In addition, the study establishes a positive response of shadow banking to a positive shock in bank liquidity. The fourth empirical paper focuses on the interaction between shadow
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banking, monetary policy and risk-taking behaviour of banks. The study finds shadow banking to be an important component of the monetary policy transmission mechanism in emerging countries. High risk increases the impact of monetary policy on shadow banking whereas lower risk weakens monetary policy transmission through the shadow banking system. Furthermore, the study argues for linkages between shadow banking and bank risk taking in the monetary policy transmission mechanism; the findings show that high risk taking occurs through the shadow banking sector. The fifth empirical paper investigates the impact of shadow banking activities on firm profitability in South Africa with the aim to establish whether South African firms benefit from shadow financial services or otherwise. Single equation cointegration methods and three measures of firm profitability were employed in the study. Several macroeconomic and bank specific variables were used as control variables. The results are mixed; showing that shadow banking has a negative impact on traditional banks’ profitability but has a positive impact on non-financial firms and the overall measures of firm profitability. The results indicate that both non-financial firms and non-bank financial institutions are benefiting from the expansion in shadow banking activities. Targeted functional regulation is suggested in order to promote economic activities in the shadow banking sector whilst at the same time limiting possible risks that may arise.
Other policy implications arising from the study points firstly, to the need to craft regulatory measures that encourage monitoring of shadow banking activities to curb contagion effects that can transfer to other jurisdictions. Secondly, regulation should also allow for growth and development of shadow banking assets to enhance economic growth. Lastly, policy coordination is necessary to ensure that the impact of monetary policy on financial markets is accounted for during policy formulation.
Description
A Thesis submitted to the Faculty of Commerce, Administration and Law, of the requirements for the Degree of Doctor of Commerce in the Department of Economics at the University of Zululand, 2019.
Keywords
Shadow banking, Financial Stability, Economics