Home Bias in Sovereign Exposure and the Probability of Bank Default - Evidence from EU Stress Test Data

41 Pages Posted: 27 Apr 2021

See all articles by Dominik Meyland

Dominik Meyland

University of St. Gallen

Dorothea Schaefer

German Institute for Economic Research (DIW Berlin); JIBS

Date Written: April 2021

Abstract

Since the European debt crisis economists and politicians discuss intensively the sovereign-bank nexus. The high activity in sovereign bond issuance required to mitigate the burden of the Covid19 crisis will rather intensify this debate than calm it down. Surprisingly, however, we still have only limited knowledge about the impact of a home bias in sovereign exposure on bank stability. This paper provides a new way to use European stress test data to study this relationship. In addition, we explore the effect on a bank’s probability of default if the existing capital requirement privilege for EU sovereign exposures were abolished. Our results support the conceptual idea behind the nexus theory. Interestingly, the effect of a home bias on bank stability is contingent on the home country’s solvency. If the home country is sufficiently solvent, investments in home sovereign bonds may improve bank stability. The findings clearly support the benefits of additional CET1 capital buffers. Regulation focusing on the home bias should account for heterogeneous effects depending on the home country’s solvency.

Keywords: Home bias, sovereign bonds, bank stability, equity requirements, financial regulation

JEL Classification: G21,G28,K15

Suggested Citation

Meyland, Dominik and Schaefer, Dorothea, Home Bias in Sovereign Exposure and the Probability of Bank Default - Evidence from EU Stress Test Data (April 2021). DIW Berlin Discussion Paper No. 1943, Available at SSRN: https://ssrn.com/abstract=3835003 or http://dx.doi.org/10.2139/ssrn.3835003

Dominik Meyland

University of St. Gallen ( email )

Bodanstrasse 8
SIAW-HSG
St.Gallen, 9000
Switzerland

Dorothea Schaefer (Contact Author)

German Institute for Economic Research (DIW Berlin) ( email )

Mohrenstraße 58
Berlin, 10117
Germany
+49 30 8978 9162 (Phone)
+49 30 8978 9104 (Fax)

JIBS ( email )

Jönköping, 55111
Sweden

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