Working Paper

The Inevitability of Shadowy Banking

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Shadowy banking is safety-net arbitrage. It employs substitutes for products and activities performed within the traditional banking sector.

The shadows obscure organizational and transactions strategies that avoid regulation and extract subsidies by adaptive innovation. Because credit support kicks in when private equity is exhausted, safety nets supply badly structured equity capital— and not insurance— to firms that engage in shadowy activities. As coerced equity investors whose liability is unlimited, taxpayers would benefit if information systems and corporate law were revised to give them much the same safeguards and rights of disclosure as a minority shareholder.