Banks’ Home-Bias in Government Bonds Holdings. Will Banks in Low-Rated Countries Invest in European Safe Bonds (ESBies)?

Abstract

This paper offers two new explanations for banks’ home bias in government bond holdings: a sovereign-based rating cap on corporates and the existence of a ‘bank tax’. These are complementary to the four explanations offered in the literature: risk shifting, gambling for resurrection, moral suasion, and a means to store liquidity for financing future investment. Collectively, they cast doubt on the European Union’s demand-led approach to investment in European safe bonds (ESBies) by banks in low-rated countries. Bank regulations such as constraints on large exposure or risk-based capital on credit risk concentration will be needed if the objective is to break the so-called “deadly embrace”.

Keywords: European banking, Bank regulation, Basel capital, Banks’ home-bias.

JEL Classification: F34, G21, G28