Open banking, shadow banking and regulation

We argue that open banking will create diverse banking models: competitive banks (serving depositors who adopt open banking) and monopolistic banks (serving the other depositors). In equilibrium, at the margin, the profit of competitive and monopolistic banks should be equal. Hence, the system-wide impact of any policy change cannot be judged solely by the impact on a typical monopolistic or competitive bank, the impact on relative profitability also matters since this can lead banks to move from one banking type to another. For example, an increase in capital requirements bites less on the profits of competitive than monopolistic banks. Some banks thus move to the (riskier) competitive sector which we show can increase overall risk in the system. A deposit rate ceiling dampens the impact of Bertrand competition, making competitive banks more profitable, so the (riskier) competitive sector grows. Hence, rather than making the system more stable, a marginal lowering of a deposit rate ceiling can increase risk. We also show that, in many scenarios, the regulator must choose between banks funding private sector projects or all banks being safe, the regulator cannot have both. This has implications for the optimal risk weights of sovereign debt. In our model, none of these effects are driven by the presence of unregulated assets/sectors nor on impacts on charter value, as is the case in papers that find outcomes that are the opposite of what was intended. We then introduce an unregulated, shadow banking sector into the model and show that the growth in shadow banking benefits monopolistic banks relative to competitive banks. This increases the size of the (low-risk) monopolistic sector, reducing overall risk in the system. We discuss policy implications.