P aper No. 907 Banks, shadow banks, and business c

Staff Working Paper No. 907

Banks, shadow banks, and business cycles Yvan Becard and David Gauthier

February 2021

Staff Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate.

Any views expressed are solely those of the author(s) and so cannot be taken to represent those of the Bank of England or to state Bank of England policy. This paper should therefore not be reported as representing the views of the Bank of England or members of the Monetary Policy Committee, Financial Policy Committee or Prudential Regulation Committee.

Staff Working Paper No. 907

Banks, shadow banks, and business cycles
Yvan Becard⁽¹⁾ and David Gauthier⁽²⁾

Abstract

Credit spreads on household and business loans move in lockstep and spike in every recession. We propose a theory as to why banks tighten their lending standards following a drop in market sentiment. The key
feature is a procyclical shadow banking sector that shifts risk from traditional banks to investors through
securitisation. We fit the model to euro‑area data and find that market sentiment shocks are the main
driver of business and financial cycles over the past two decades.

Key words: Credit spreads, shadow banks, business cycles, financial shocks.

JEL classification: E32, E44, G21, G23.

(1) PUC‑Rio. Email: [e-mail]‑rio.br

(2) Bank of England. Email: [e-mail]

We are grateful to Florin Bilbiie, Ambrogio Cesa‑Bianchi, Cristiano Cantore, Simon Gilchrist, Timo Hiller, Michel Juillard, Ricardo Masolo, Benjamin Moll and Ricardo Reis for helpful discussions.

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