Effects of Securitisation and Covered Bonds on Bank Stability

Abstract

This paper empirically investigates the relationship of securitization and covered bonds with bank stability and highlights that this relation varies with the level of a bank's involvement in a specific instrument. The study uses the data from 46 securitizing and covered bond issuing listed banks in Europe for 2000-2014. The initial results show that some banks have been heavily involved in securitization activity, while covered bond issuance does not go beyond a certain limit. The results obtained using a quadratic model and a generalized additive model show a U-shaped relationship between securitization and systemic risk of the banks. However, this relationship is reversed for covered bonds. Small issuance of these bonds fails to provide the intended benefits and increases banks' risk. Further investigation reveals the presence of a strong size effect. The systemic risk of smaller banks increases after the issuance of covered bonds, while larger banks remain unaffected. The study does not support imposing uniform limits on covered bond issuance; instead such limits should be linked with the bank size. However, some regulatory framework is needed to limit banks' involvement in securitization.

Keywords: Securitisation, Covered Bonds, European Banks, Systemic Risk, Bank Stability, Non-Linearity