From Policy to Regulation
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This chapter, which builds on the insights generated in Chap. 7, takes the discussion a couple of notches up. Starting from how shadow banking emerged, the analysis focuses on the question how regulation can help manage an industry it helped creating itself. Two concepts are central in the analysis: regulatory arbitrage (the technique through which simply put one can achieve the same economic outcome by using a different legal technique or transaction and often subject to different (i.e. lower) capital requirements) and second the creation of private safe assets. What exactly is a safe asset and can safe assets be produced privately or is that only possible by sovereigns in the current financial system? If privately created safe assets are inherently instable, the central bank and the taxpayer essentially underwrite the shadow banking industry on an ongoing basis. Contract imperfection, director liability, limited liability for corporations, bankruptcy laws and moral hazard are then topics that need to be brought into the discussion.