Domestic Banks as Lightning Rods? Home Bias and Information during Eurozone Crisis

58 Pages Posted: 7 Nov 2016 Last revised: 26 Jun 2018

See all articles by Orkun Saka

Orkun Saka

University of Sussex; London School of Economics & Political Science (LSE)

Multiple version iconThere are 2 versions of this paper

Date Written: June 20, 2018

Abstract

European banks have been criticized for holding excessive domestic government debt during economic downturns, which may have intensified the diabolic loop between sovereign and bank credit risks. By using a novel bank-level dataset covering the entire timeline of the Eurozone crisis, I first re-confirm that the crisis led to the reallocation of sovereign debt from foreign to domestic banks. This reallocation was only visible for banks as opposed to other domestic private agents and it cannot be explained by the banks' risk-shifting tendency. In contrast to the recent literature focusing only on sovereign debt, I show that banks' private sector exposures were (at least) equally affected by a rise in home bias. Finally, consistent with these patterns, I propose a new debt reallocation channel based on informational frictions and show that informationally closer foreign banks increase their relative exposures when sovereign risk rises. The effect of informational closeness is economically meaningful and robust to the use of different information measures and controls for alternative channels of sovereign debt reallocation.

Keywords: Home bias, Information asymmetries, Eurozone crisis, Sovereign debt

JEL Classification: F21, F34, F36, G01, G11, G21

Suggested Citation

Saka, Orkun, Domestic Banks as Lightning Rods? Home Bias and Information during Eurozone Crisis (June 20, 2018). Available at SSRN: https://ssrn.com/abstract=2865247 or http://dx.doi.org/10.2139/ssrn.2865247

Orkun Saka (Contact Author)

University of Sussex ( email )

Sussex House
Falmer
Brighton, Sussex BNI 9RH
United Kingdom

London School of Economics & Political Science (LSE) ( email )

Houghton Street
London, WC2A 2AE
United Kingdom

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