The impact of complex financial instruments on banks’ vulnerability: empirical evidence on SSM banks

Tommaso Perez (), Francesco Potente (), Andrea Carboni (), Alberto Di Iorio () and Jacopo Raponi ()
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Tommaso Perez: Bank of Italy
Francesco Potente: Bank of Italy
Andrea Carboni: Bank of Italy
Alberto Di Iorio: Bank of Italy
Jacopo Raponi: Bank of Italy

No 633, Questioni di Economia e Finanza (Occasional Papers) from Bank of Italy, Economic Research and International Relations Area

Abstract: Level 2 (L2) and Level 3 (L3) assets and liabilities represent a substantial portion of European banks’ balance sheets, and valuing them is extremely difficult, since no liquid market prices are available. This paper relies on a large panel of euro-area banks between 2014 and 2019, and two different econometric frameworks, in order to estimate the relationship between the holdings of selected instruments (L2, L3 and Non-Performing Loans, NPLs) and banks’ key performance and risk profile metrics, namely Credit Default Swaps (CDSs), Price-to-Book (PtB) ratios and Z-scores. It finds that larger holdings of L2 tend to be associated with higher CDSs, at least in the short run, while larger amounts of NPLs and L3 tend to characterize banks with higher CDSs, lower PtB ratios and worse Z-scores, other things being equal.

Keywords: fair value accounting; level 2 instruments; level 3 instruments; non-performing loans; prudential regulation; panel data models (search for similar items in EconPapers)
JEL-codes: C33 G21 G28 M41 (search for similar items in EconPapers)
Date: 2021-07
New Economics Papers: this item is included in nep-acc, nep-ban, nep-eec, nep-isf and nep-rmg
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