Banks’ Sovereign Exposures: In Search of New Rules

40 Pages Posted: 3 Jun 2020

See all articles by Angelo S. Baglioni

Angelo S. Baglioni

Catholic University of the Sacred Heart of Milan

Francesco Cefalà

Catholic University of the Sacred Heart of Milan

Date Written: April 2020

Abstract

We examine the reform of the prudential treatment of banks’ sovereign exposures, with the purpose of introducing risk-sensitive capital charges and limiting the home bias. We consider six different options and measure their impact on the CET1 ratio of 82 banks from 10 euro-area countries, participating in the 2019 EBA EU-wide transparency exercise and subject to the ECB supervision. Our evidence shows that the BCBS (2017) proposal is the one with the most evenly distributed impact across countries, in terms of CET1 ratio decline. That proposal has the advantage of targeting two goals, risk sensitivity and diversification, with two independent instruments: rating-based risk weights and concentration add-ons. As a consequence, it is the only one introducing an incentive for banks located in all countries, low rated and high rated ones, to reduce their home bias. All the other proposals suffer severe drawbacks. Some focus on one objective only: either risk sensitivity or diversification. Other ones are strongly unbalanced: they introduce a heavy penalization for banks located in low rated countries, without addressing the home bias of banks located in high rated countries. Several options are prone to pro-cyclicality: we measure this effect by simulating the impact of a two-notch downgrading of high debt countries on the CET1 ratio of banks. Some relevant cross-country effects emerge from our analysis, due to the large cross-country exposures of a few intermediaries.

Keywords: Bank, Sovereign Exposure, Credit Risk, Capital Ratio, Prudential Regulation

JEL Classification: G21, G28, H63

Suggested Citation

Baglioni, Angelo and Cefalà, Francesco, Banks’ Sovereign Exposures: In Search of New Rules (April 2020). Available at SSRN: https://ssrn.com/abstract=3592588 or http://dx.doi.org/10.2139/ssrn.3592588

Angelo Baglioni (Contact Author)

Catholic University of the Sacred Heart of Milan ( email )

Largo Gemelli, n.1
Milano, 20123
Italy
390272344024 (Phone)
390272342781 (Fax)

Francesco Cefalà

Catholic University of the Sacred Heart of Milan ( email )

Largo Gemelli, 1
Via Necchi 9
Milan, MI 20123
Italy

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