Bond Issued by Italian Banks: Risk and Return Characteristics

Abstract

Bonds are among the main source of external funding for Italian banks and one of the most important financial assets held by Italian households. The bond-to-deposit ratio of Italian banks is about 40%, the highest value in Europe after Germany, while the share of bank bonds on Italian households’ portfolio is by far the highest among major industrialized economies. Hence, understanding risk and return characteristics of bank bonds is crucial for investor protection policies. This work provides evidence on such characteristics analyzing bank bonds issued from July 2007 to June 2009. During this period, retail investors were offered mainly plain-vanilla bonds (79%), followed by structured (10%), callable (8%) and step up/down bonds (3%). Approximately 64% of the securities sold to retail investors can be classified as very low credit and market risk, while around 4% have high credit or market risk. However, due to the small average issue size, liquidity risk is high: only 9% of the bonds (approximately 30% of the total amount) are really liquid. The returns of bonds sold to retail investors are weakly related to credit and liquidity risks and on average lower than those of Italian government bonds with similar maturity; ceteris paribus, returns offered to retail investors are lower than that demanded by institutional investors by about 90-100 basis points.