Economic uncertainty and shadow banking in India

Abstract Using firm-level data from 2010 to 2023, this study examines the causal relationship between economic policy uncertainty (UEP) and shadow banking practices among Indian non-financial firms (NFEs). The findings show a strong positive correlation: firms’ involvement in shadow banking increases by 0.5809 standard deviations for every standard deviation increase in UEP. State-owned enterprises (SOEs) and businesses with less financial restraints are especially affected. According to the mechanism analysis, the main factors influencing this relationship are the yield difference between financial and real investments and financing frictions. This work adds to the body of knowledge on corporate financialization by revealing how UEP influences the behavior of shadow banks. It also provides insights into the wider effects of policy uncertainty on company investment and financial stability.