Securitization, connectedness and shadow banking

This paper shows how securitization changes the linkages and the systemic risks in the regulated and unregulated "shadow" banking system. The theoretical framework includes an analysis of the transfer of idiosyncratic, systematic and systemic risks and the use of the proceeds from the transfer. The incentives of regulated banks to securitize and transfer risks to the shadow banking system and the implications for financial stability are discussed. The empirical analysis shows that securitization is associated with (i) increased connectedness of banks and (ii) increased systemic risk exposure of banks. Both the theoretical and the empirical analysis identify decreased risks on average but increased systemic risks that are most likely hidden and falsely interpreted as resilience. The results suggest that more research on the size and the risks of the shadow banking system is warranted.