How does the shadow banking system respond to changes in capital regulation of commercial banks? We propose a quantitative general equilibrium model with regulated and unregulated banks to study the unintended consequences of regulation. Tighter capital requirements for regulated banks cause higher convenience yield on debt of all banks, leading to higher shadow bank leverage and a larger shadow banking sector. At the same time, tighter regulation eliminates the subsidies to commercial banks from deposit insurance, reducing the competitive pressures on shadow banks to take risks. The net effect is a safer financial system with more shadow banking. Calibrating the model to data on financial institutions in the US, the optimal capital requirement is around 16

Should regulators encourage the migration of trade from over-the-counter (OTC) to centralized markets? To address this question, we study a model in which banks make costly decisions to participate in an OTC market, a centralized market, or both markets at the same time. Banks differ in their ability to take large positions, what we call their trading capacity. In equilibrium, intermediate-capacity banks find it optimal to participate in the centralized market. In contrast, low- and high-capacity banks find it optimal to participate in the OTC market, due to an endogenous complementarity. Namely, low-capacity banks receive worse terms of trade than in the centralized market but better risk sharing, thanks to the intermediation services offered by high-capacity banks. High-capacity banks receive worse risk sharing than in the centralized market, but profit from the provision of intermediation services to low-capacity banks. While the social optimum has qualitatively similar participation patterns, it prescribes that more customers migrate to the centralized market, and that more dealers enter the OTC market