Return on equity is often associated with prudent risk-taking and the attraction of new clients in advanced economies like the United States, where shadow banks are not regulated. Researchers have contended that freedom from regulation encourages risk-taking and earning of higher profits, but there is a lack of empirical evidence addressing this relationship. The purpose of this quantitative study was to investigate whether lack of regulations result in increased return on equity. The theoretical framework was regulatory arbitrage by Ricks M, Gennaioli N, Shleifer A, and Vishny R. The research question addressed the relationship between regulation, profit margin, leverage, asset turnover, economic condition, and strategy, and the bottom-line of banks (traditional and shadow) as measured by return on equity. A quasi-experimental design was used to examine data from 42 annual returns filed using Security and Exchange Commission (SEC) Form 10-K from U.S. banks with Standard Industrial Classification (SIC) Code 6021 and 6211. Multiple regression was used to analyze the data. Results indicated that regulation did not show any significant correlation with the bottom-line of banks as measured by return on equity. However, there was a significant correlation between the bottom-line banks and other independent variables including profit margin, leverage, and asset turnover. This study contributes to positive social change by assisting regulators and lawmakers in improving their roles in regulating traditional and shadow banks, thereby reducing the likelihood of crises in the U.S. banking system.

Since the start of the financial crisis in 2008, the Federal Reserve has been engaging in quantitative easing. Quantitative easing is a form of open market operation in which the Federal Reserve buys long-term U.S. government and other securities, versus traditional open market operations that occur through the short-term Treasury bill market. At the same time, the shadow bank system, which is a system of financial intermediaries that perform unregulated credit intermediation outside of traditional banks, has contracted significantly. Some argue that this contraction is due to a collateral crunch induced by quantitative easing in the shadow bank system—a crunch that occurred when the Federal Reserve’s quantitative easing program took high-quality collateral off the market. I will focus specifically on repurchase agreements, an instrument within the shadow banking that uses the same types of securities that the Federal Reserve has been buying during quantitative easing as collateral, to determine whether quantitative easing has led to a contraction of the repurchase agreement market. I find that increases in Federal Reserve asset holdings from 2005-2013, and specifically during QE1, are associated with decreases in primary dealer repurchase agreements. This shows that under certain circumstances, Federal Reserve asset purchases lead to contractions in the shadow bank system. This paper aims to increase understanding of how monetary policy affects shadow banking and understanding of the unintended consequences of monetary policy, such as decreased shadow bank lending caused by quantitative easing.

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