The Impact of Complex Financial Instruments on Banks’ Vulnerability: Empirical Evidence on SSM Banks

29 Pages Posted: 30 Jul 2021

Date Written: July 29, 2021

Abstract

Level 2 (L2) and Level 3 (L3) assets and liabilities represent a substantial portion of European banks’ balance sheets, and valuing them is extremely difficult, since no liquid market prices are available. This paper relies on a large panel of euro-area banks between 2014 and 2019, and two different econometric frameworks, in order to estimate the relationship between the holdings of selected instruments (L2, L3 and Non-Performing Loans, NPLs) and banks’ key performance and risk profile metrics, namely Credit Default Swaps (CDSs), Price-to-Book (PtB) ratios and Z-scores. It finds that larger holdings of L2 tend to be associated with higher CDSs, at least in the short run, while larger amounts of NPLs and L3 tend to characterize banks with higher CDSs, lower PtB ratios and worse Z-scores, other things being equal.

Keywords: fair value accounting, level 2 instruments, level 3 instruments, non-performing loans, prudential regulation, panel data models

JEL Classification: G21, G28, C33, M41

Suggested Citation

Tommaso, Perez and Potente, Francesco and Carboni, Andrea and Di Iorio, Alberto and Raponi, Jacopo, The Impact of Complex Financial Instruments on Banks’ Vulnerability: Empirical Evidence on SSM Banks (July 29, 2021). Bank of Italy Occasional Paper No. 633, Available at SSRN: https://ssrn.com/abstract=3896326 or http://dx.doi.org/10.2139/ssrn.3896326

Perez Tommaso

Bank of Italy ( email )

Via Nazionale 91
Rome, 00184
Italy

Francesco Potente

Bank of Italy ( email )

Via Nazionale 91
Rome, 00184
Italy

Andrea Carboni

Bank of Italy ( email )

Via Nazionale 91
Rome, 00184
Italy

Alberto Di Iorio (Contact Author)

Bank of Italy ( email )

Via Nazionale 91
Rome, 00184
Italy

Jacopo Raponi

Bank of Italy ( email )

Via Nazionale 91
Rome, 00184
Italy

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