Banks’ home bias and public debt sustainability

Banks’ home bias and public debt sustainability

While acknowledging the current presence of both effects, we aimed to substantiate the latter effect, from your home bias to fiscal outcomes, by accounting for endogenity issues. 4

Our main findings broadly hold in robustness checks. For example, dropping outliers such as for example Greece and Japan from the united states sample will not change the empirical results. The findings are also generally robust to alternative regression methodologies aswell as to the utilization of different home bias measures. The only exception is that while we look for a negative relationship between our preferred home bias measure (holdings of domestic sovereign debt in accordance with total assets) and advanced markets borrowing costs, the partnership is positive for the house bias measure which has total public debt as the denominator. This finding isn’t surprising because this way of measuring home bias mainly reflects the diversification angle instead of banks’ preference for sovereign debt. 5

Conclusion

Overall, the empirical results strongly claim that home bias matters for debt sustainability. High home bias, which in some instances is tantamount to presenting a captive investor base, might provide fiscal breathing space, but delays in fiscal consolidation could possibly postpone problems until debt reaches dangerously high levels. The breathing space is basically the consequence of the favourable impact of high home bias on rollover risk which is specially evident during crisis periods, but isn’t more likely to yield better fiscal outcomes. The empirical analysis in this column, which examines the multi-faceted impact of home bias, provides analytical support for anecdotal evidence in this regard. For instance, through the recent crisis period countries with a captive domestic investor base faced less market pressure on rollover needs, and for that reason enjoyed more breathing space while attempting difficult fiscal consolidations (or during periods of lax fiscal discipline).

Disclaimer: This column summarises the primary findings of an IMF working paper by Asonuma, Bakhache, and Hesse (2015). The views expressed in the following paragraphs are those of the authors and really should not be related to the IMF, its Executive Board, or its management. Any errors and omissions will be the sole responsibility of the authors.

References

Acharya, V V, I Drechsler, and P Schnabl (2012), “AN ACCOUNT of Two Overhangs: The Nexus of Financial Sector and Sovereign Credit Risks,” Banque de France Financial Stability Review, No.16, April 2012.

Acharya, V V, and S Steffen (2013), “THE BEST Carry Trade Ever? Understanding Eurozone Bank Risks,” NBER Working Paper No. 19039, May 2013.

Andritzky, J R (2012), “Government Bonds and Their Investors: WHAT EXACTLY ARE the reality and Do They Matter?” IMF Working Paper 12/158, (Washington).

Arslanalp, S, and T Poghosyan (2014), “Foreign Investor Flows and Sovereign Bond Yields in Advanced Economies,” IMF Working Paper 14/27, (Washington).

Arslanalps, S, and T Tsuda (2012), “Tracking Global Demand for Advanced Economy Sovereign Debt,” IMF Working Paper 12/284, (Washington).

Asonuma, S, S Bakhache, and H Hesse (2015), “Is Banks’ Home Bias Good or Harmful to Public Debt Sustainability?” IMF Working Paper 15/44, (Washington).

Bank of International Settlement (2011), “The Impact of Sovereign Credit Risk on Bank Funding Condition,” CGFS Paper, No. 43.

Baldacci, E, I Petrova, N Belhocine, G Dobrescu, and S Mazraani (2011), “Assessing Fiscal Stress,” IMF Working Paper 11/100 (Washington).

Cruces, J, and C Trebesch (2013), “Sovereign Defaults: The cost of Haircuts,” American Economic Journal: Macroeconomics, Vol. 5(3), pp. 85-117.

Ebeke, C, and Y Lu (2014), “Emerging Market Local Currency Bond Yields and Foreign Holdings in the Post-Lehman Period-A Fortune or Misfortune?” IMF Working Paper 14/29 (Washington).

IMF (2012), “Global Financial Stability Report, April (Washington).

— (2011), “Global Financial Stability Report, September (Washington).

Merler, S, and J Pisani-Ferry (2012), “Hazardous Tango: Sovereign-Bank Interdependence and Financial Stability in the Euro area,” Banque de France Financial Stability Review, No. 16, April 2012.

Footnotes

1 Banks’ home bias typically denotes the preference of domestic banks for holding domestic sovereign debt instruments in comparison to other sovereign debt instruments. However, both mostly used measures of home bias in the literature (holding of domestic sovereign debt in percent of total assets, and in percent of total debt) have a tendency to also capture other factors such as for example investor base diversification.

[2] This is among the reasons that the 2011 European Banking Authority (EBA) stress test findings weren’t perceived as credible therefore the recapitalisation exercise forced European banks to mark-to-market all their securities holdings (e.g., IMF 2011 and 2012).

3 In the European periphery, external market pressures and soaring sovereign yields have forced peripheral countries to start out implementing a number of the overdue reforms. Decisive monetary policy by the ECB has certainly helped to supply a backstop to the peripheral domestic banks, that was the predominant factor for compressing peripheral sovereign spreads.

[4] Specifically, the empirical panel regression methodology makes up about endogeneity issues between home bias and public debt through the use of instruments.

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