Neglected risks, financial innovation, and financial fragility

► We present a new model of shadow banking with several results. ► Growth of shadow banking is driven by growth in outside wealth. ► Banks hold AAA-rated assets as collateral for riskless debt finance. ► Bank assets and leverage are procyclical. ► Banks retain systematic risk as they diversify idiosyncratic risk. ► When investors neglect tail downside risk, banks are vulnerable to massive losses and liquidity dryups.