Gennaioli, Alberto Martin, Stefano Rossi · Nicola Gennaioli, Alberto Martin, Stefano Rossi Paris,...

Banks Government Bonds and Default:Banks, Government Bonds, and Default:What do the Data Say?y

Nicola Gennaioli, Alberto Martin, Stefano RossiNicola Gennaioli, Alberto Martin, Stefano RossiParis, December 17, 2012

Banks and Bonds: A Dangerous EmbraceBanks and Bonds: A Dangerous Embrace

R t E C i i G t d f lt d• Recent European Crisis: Government default endangers domestic bank stability– PIIGS Banks entered crisis strongly exposed to theirPIIGS Banks entered crisis strongly exposed to their governments’ bonds

– Further increased their exposures during crisisPIIGS B k h b i i d G k D f l– PIIGS Banks hurt by sovereign crises – and Greek Default –through their sovereign bondholdings

• “Europe’s troubled banks and broke governments are in a dangerous embrace”

The Economist, December 17, 2011

Intro Data Hypotheses and Empirical Strategy Results

Why This Dangerous Embrace?Why This Dangerous Embrace?R t f t h d t il d t tb k th f i• Recent facts hard to reconcile under textbook theory of sovereign borrowing with perfect discrimination and penalties

• Gennaioli, Martin, and Rossi (2012) build a model where public defaults destroy the net worth of banks that hold public bonds, hindering financial intermediationhindering financial intermediation– Using aggregate data, GMR find that after a sovereign default financial

intermediation drops more pronounced in those banking sectors that hold more government bonds g

• To assess empirically the relationship between defaults and the b ki t h h i t b dbanking system, however, much remains to be done– What about bank‐level variation of bondholdings and loans?– What about normal times vs. crisis times bondholdings?


Our PaperOur PaperWe use BANKSCOPE data to address three questions

1. Is the European crisis special or have bank bondholdings played an important role in previous sovereign debt crises as well?an important role in previous sovereign debt crises as well?

2. If banks stand to lose from sovereign default, why do they hold g , y yso many public bonds in the first place? – Is it because of demand during normal times, or is it because they choose

(or are induced) to buy bonds during sovereign debt crises? ( ) y g g

3. Do greater bondholdings reduce bank loans during sovereign crises? If so is this due primarily to bonds accumulated duringcrises? If so, is this due primarily to bonds accumulated during normal times, or during crises times?


RoadmapRoadmap

1. Data

2. Hypotheses and Empirical Strategy

3 Results3. Results


1. Data

DataData• Bank‐level data from BANKSCOPE dataset (Bureau van Dijk):

Provides information on a broad range of bank characteristics– Provides information on a broad range of bank characteristics– BANKSCOPE suitable for international comparisons because data is harmonized

• Crucial: BANKSCOPE reports banks’ holdings of public bonds– However, does not say the nationality of the bonds– We use IMF and EU stress test data to validate this informationWe use IMF and EU stress test data to validate this information

• Main sample: 4,723 banks in 151 countries; 25,132 bank‐year obs.– Commercial, cooperative and savings banks account for 92% of our sample; investment

banks for 1.6%; rest are holdings, real estate, and other credit institutions– Sample construction: start with full data; filter out duplicate records, banks with

negative value of assets banks with total assets < $100 000 years < 1997 whennegative value of assets, banks with total assets < $100,000, years < 1997 when coverage is less systematic. Get: 10,281 banks in 174 countries over 1998‐2010 (58,830 bank‐year observations)

– Further impose: two consecutive years of data; data is available on size, leverage, risk taking profitability loans Central Bank balances and other interbank ratiostaking, profitability, loans, Central Bank balances and other interbank ratios


Bondholdings: Bankscope v. IMF


Bondholdings: Bankscope v. EU Stress Test


Descriptive StatisticsDescriptive StatisticsFull Sample

EU Stress Test


Pairwise CorrelationsPairwise Correlations


Defaults in Our SampleDefaults in Our Sample


2. Hypotheses and Empirical Strategy

Three Views of Banks’ BondholdingsThree Views of Banks Bondholdings

Li idit i• Liquidity view– Banks hold public bonds on a regular basis (normal times) to store

liquidity and to post them as collateral in borrowing arrangements (Gennaioli Martin and Rossi 2012 Bolton and Jeanne 2012)(Gennaioli, Martin, and Rossi 2012, Bolton and Jeanne 2012)

– Based on general idea that government bonds provide liquidity (Holmstrom and Tirole 1998)

• Risk‐taking view– Banks demand public bonds in anticipation of, or in response to, p p , p ,

sovereign crises to chase high returns, perhaps without fully internalizing the systemic consequences of doing so

• Government intervention view– Banks hold public bonds because the government induces them to do so,

using capital regulation in normal times and moral suasion during crisesusing capital regulation in normal times and moral suasion during crises times (e.g., Livshits 2009, Basu 2010)


Predictions


Normal times v Crisis times BondsNormal‐times v. Crisis‐times Bonds

• Decompose bank bondholdings bi,c,t

i,c,ti,c,t ib b b

Time varyingTime-invariant("crisis times")("normal times")

-

• Further decompose time‐invariant and time‐varying components

b b b i,ci c

Bank levelCountry level

b b b--

i,c,t i,c,tc,t

Bank levelCountry-level

b b b-


Variance DecompositionVariance Decomposition


Our TestsOur Tests1 E i b k ’ d d f b dh ldi ( d f i i1. Estimate banks’ demand for bondholdings (and of its various

components)– First, look at bank‐level: study bondholdings in “normal times” andFirst, look at bank level: study bondholdings in normal times and

during default crises– Second, look at country level: study bondholdings in “normal times”

and during default crisesand during default crises

2. Estimate effect of bondholdings (and of its various g (components) on banks’ changes in loans during default– Do banks more exposed to government bonds cut their loans more

during default?during default? – Which of the various components of bondholdings demand explain

more of this variation?


3. Results

Determinants of Bank‐level time‐invariant bondholdings


Determinants of Country‐level time‐invariant bondholdings

Summary of Bondholdings DemandSummary of Bondholdings Demand

N l i b dh ldi f 80% f l i i f• Normal‐time bondholdings account for 80% of total variation of bondholdings in our sample– Largely explained by banks’ demand for liquidityLargely explained by banks demand for liquidity

• Default episodes alone explain 14% of time variation of bonds– Banks take 16% more bonds during default– Differences with normal times: esp. larger/more profitable banks load up on

government bonds during default And esp financially developed countriesgovernment bonds during default. And esp. financially developed countries – Consistent with risk taking and/or government intervention through moral

suasion during crises

• Next: do bondholdings affect changes in loans during default?


Bondholdings and Changes in Loans


Summary of Results – Correlations

X


Summary of Results – MagnitudeSummary of Results – MagnitudeA 10% i i b dh ldi d i i i t• A 10% increase in bondholdings during crises associate with 2.4% subsequent decrease in loans– 70% of this decrease explained by normal‐times70% of this decrease explained by normal times bondholdings

• Normal‐times bondholdings account for 80% of total volatility of bondholdings

• Results mostly consistent with liquidity view of bondholdings during normal timesbondholdings during normal times– Government intervention through moral suasion and risk taking have some explanatory power during crises


Gennaioli, Alberto Martin, Stefano Rossi · Nicola Gennaioli, Alberto Martin, Stefano Rossi Paris,...

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