Asset Encumbrance and Bank Risk: Theory and First Evidence from Public Disclosures in Europe

53 Pages Posted: 27 Aug 2021

See all articles by Albert Banal-Estanol

Albert Banal-Estanol

City University

Enrique Benito

City, University of London

Dmitry Khametshin

Banco de España

Jianxing Wei

University of International Business and Economics (UIBE) - School of Banking and Finance

Date Written: August 25, 2021

Abstract

We document that overcollateralisation of banks’ secured liabilities is positively associated with the risk premium on their unsecured funding. We rationalize this finding in a theoretical model in which costs of asset encumbrance increase collateral haircuts and the endogenous risk of a liquidity-driven bank run. We then test the model’s predictions using a novel dataset on asset encumbrance of the European banks. Our empirical analysis demonstrates that banks with more costly asset encumbrance have higher rates of overcollateralisation and rely less on secured debt. Consistent with theory, the effects are stronger for banks that are likely to face higher fire-sales discounts. This evidence acts in favour of the hypothesis that asset encumbrance increases bank risk, although this relationship is rather heterogeneous.

Keywords: asset encumbrance, collateral, bank risk, credit default swaps

JEL Classification: G01, G21, G28

Suggested Citation

Banal-Estanol, Albert and Benito, Enrique and Khametshin, Dmitry and Wei, Jianxing, Asset Encumbrance and Bank Risk: Theory and First Evidence from Public Disclosures in Europe (August 25, 2021). Banco de Espana Working Paper No. 2131, Available at SSRN: https://ssrn.com/abstract=3911225 or http://dx.doi.org/10.2139/ssrn.3911225

Albert Banal-Estanol (Contact Author)

City University

Khagan
Bangladesh

Enrique Benito

City, University of London ( email )

Northampton Square
London, EC1V 0HB
United Kingdom

Dmitry Khametshin

Banco de España ( email )

Alcala 50
Madrid 28014
Spain

Jianxing Wei

University of International Business and Economics (UIBE) - School of Banking and Finance ( email )

No.10, Huixindong Street
Chaoyang District
Beijing, 100029
China

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