'Regulatory Arbitrage and Systemic Liquidity Crises'
We derive a novel bank run equilibrium within a standard banking framework. Intermediaries optimally rely on wholesale funding to manage liquidity needs, setting the stage for systemic runs: When some intermediaries are subject to a run, they raise funds by liquidating their assets. Fire sales in turn induce an overall scarcity of liquid funds, depressing asset prices and hence deteriorating the funding conditions of other intermediaries in the market for secured wholesale funding. We apply the concept of systemic runs in a model in which regulated banks and shadow banks coexist. First, we show that even without contractual linkages between the two sectors and despite absence of runs on regulated banks, shadow banking panics can cause insolvency of the regulated banking sector. Second, from a social planner's perspective, the shadow banking sector grows too large in equilibrium due to a pecuniary externality. Third, prudential regulation and central bank interventions change the equilibrium composition of the financial system and affect welfare in non-standard ways.