The impact of central bank liquidity support on banks’ sovereign exposures

Leo de Haan, Sarah Holton and Jan Willem End

Applied Economics, 2021, vol. 53, issue 15, 1788-1806

Abstract: We empirically analyse the relationship between longer term central bank liquidity support and banks’ exposures to governments, using difference-in-differences panel regressions and propensity score matching on a large sample of banks in the euro area. The research question is whether the liquidity operations, which were introduced to prevent disorderly deleveraging, can also be linked to unintended changes in banks’ asset allocations, in particular to carry trades in government bonds. The results show that unconditional and conditional refinancing operations have a different effect on banks’ government exposures. Unconditional longer-term refinancing operations went together with more carry trades in stressed countries, i.e. banks borrowing more while increasing their holdings of government bonds. In contrast, refinancing operations that were conditional on banks’ lending were not associated with such carry trades, highlighting the benefits of conditionality attached to long-term refinancing operations.

Date: 2021
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Working Paper: The impact of central bank liquidity support on banks’ balance sheets (2019)
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DOI: 10.1080/00036846.2020.1853667

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