How Banks Respond to Distress: Shifting Risks in Europe’s Banking Union

Mark Mink, Rodney Ramcharan and Iman Lelyveld
Additional contact information
Rodney Ramcharan: Marshall School of Business, University of Southern California

No 20-006/IV, Tinbergen Institute Discussion Papers from Tinbergen Institute

Abstract: This paper uses granular bond portfolio data to study how banking systems across the European Union (EU) adjust their asset holdings in response to regulatory solvency shocks. We also study the impact of these shocks at financial intermediaries on the prices of bonds in their portfolio. Despite the creation of a Single Supervisory Mechanism (SSM) in the EU, we find that risk-shifting interacts with regulatory arbitrage motives to explain how banks adjust their portfolios after adverse solvency shocks. After regulatory solvency declines, banks increase their exposure to domestic bonds, including higher yielding but zero risk-weight sovereign bonds. The increase in banking system risk might therefore be even larger than the decline in risk-weighted solvency ratios suggests. Distress in the banking system also feeds back onto bond prices. Bonds owned by less-well capitalized banking systems trade at a discount relative to otherwise similar bonds owned by better capitalized intermediaries.

Keywords: Bank capital; portfolio allocation; risk shifting; SSM (search for similar items in EconPapers)
JEL-codes: G11 G12 G15 G21 (search for similar items in EconPapers)
Date: 2020-02-04
New Economics Papers: this item is included in nep-ban, nep-cfn and nep-eec
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

Downloads: (external link)
https://papers.tinbergen.nl/20006.pdf (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:tin:wpaper:20200006

Access Statistics for this paper

More papers in Tinbergen Institute Discussion Papers from Tinbergen Institute Contact information at EDIRC.
Bibliographic data for series maintained by Tinbergen Office +31 (0)10-4088900 (discussionpapers@tinbergen.nl).