Lender of Last Resort versus Buyer of Last Resort – Evidence from the European Sovereign Debt Crisis

66 Pages Posted: 12 Apr 2016 Last revised: 12 Apr 2017

Viral V. Acharya

New York University - Leonard N. Stern School of Business; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER); New York University (NYU) - Department of Finance

Diane Pierret

HEC - University of Lausanne

Sascha Steffen

University of Mannheim - Business School; Centre for European Economic Research (ZEW)

Date Written: April 11, 2017

Abstract

We document channels of monetary policy transmission to banks following two significant interventions of the European Central Bank (ECB) during the sovereign debt crisis. As a lender of last resort via the long-term refinancing operations (LTROs), the ECB improved the collateral value of short-term sovereign bonds of peripheral countries. Banks in the peripheral countries became excessively dependent on public funds and increased their exposure to domestic debt. An elevated concentration of peripheral sovereign bonds in the portfolios of risky banks increased fire sale risk, increasing the riskiness of both banks and sovereign bonds. In contrast, the ECB’s announcement of being a potential buyer of last resort via the Outright Monetary Transaction (OMT) program attracted new investors to the sovereign bond market, reduced concentration and fire sale risk, and permanently improved solvency conditions for eurozone banks.

Keywords: Monetary policy, fire sale risk, bank risk, sovereign debt, ECB

JEL Classification: G01, G21, G28

Suggested Citation

Acharya, Viral V. and Pierret, Diane and Steffen, Sascha, Lender of Last Resort versus Buyer of Last Resort – Evidence from the European Sovereign Debt Crisis (April 11, 2017). ZEW - Centre for European Economic Research Discussion Paper No. 16-019. Available at SSRN: https://ssrn.com/abstract=2762265 or http://dx.doi.org/10.2139/ssrn.2762265

Viral V. Acharya

New York University - Leonard N. Stern School of Business ( email )

44 West 4th Street
New York, NY NY 10012
United States

HOME PAGE: http://pages.stern.nyu.edu/~sternfin/vacharya/public_html/~vacharya.htm

Centre for Economic Policy Research (CEPR)

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

New York University (NYU) - Department of Finance

Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States

Diane Pierret

HEC - University of Lausanne ( email )

Institute of Banking and Finance
Unil Dorigny, Batiment Extranef
Lausanne, 1015
Switzerland

Sascha Steffen (Contact Author)

University of Mannheim - Business School ( email )

L9, 1-2
Mannheim, 68131
Germany

HOME PAGE: http://www.sascha-steffen.de

Centre for European Economic Research (ZEW) ( email )

L7, 1
Mannheim, 68161
Germany
+496211235140 (Phone)

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