Shadow Banking, Version #2 (Asset-Backed Commercial Paper) Bank, after securitization Assets Liabilities Cash 100 92 Deposits 8 Equity (required capital = 0) SPV Liquidity Excess Guarantee Spread Assets Liabilities Sec. Loans 100 100 Asset-Backed CP Money Market Mutual Fund Assets Liabilities Asset-backed CP 100 100 Money Market AccountsShadow Banking, Version #1 (Securitization with REPO Finance) Bank, after securitization Assets Liabilities Cash 95 92 Deposits Residual 5 8 Equity (required capital = 5) SPV Assets Liabilities Sec. Loans 100 80 AAA Rated Bonds 15 BBB Bonds 5 Residual Investment Banks Assets Liabilities AAA Rated Bonds 80 75 Repo Borrowing 5 Equity Money Market Mutual Fund Assets Liabilities Reverse Repo 75 75 Money Market AccountsBank Kun Example Time T = 0, the balance sheet of Bank 1 and Bank 2 is as follows: Bank 1 Bank 2 Assets Liabilities + Equity Assets Liabilities + Equity Cash $800 Deposits $1,000 Cash $800 Deposits $1,000 MBSs $1,000 SME Loans $400 (non-financial) Capital $800 MBSs $600 Capital $800 Total $1,800 Total $1,800 Total $1,800 Total $1,800 Time T = 1, Bank 1 and Bank 2 write-off the MBS portfolio Bank 1 Bank 2 Assets Liabilities + Equity Assets Liabilities + Equity Cash $800 Deposit $1,000 Cash $800 Deposits $1,000 MBSs So SME Loans $400 ( non-financial) Capital -$200 MBSs $o Capital $200 Total $800 Total $800 Total $1,200 Total $1,200