Abstract
In this paper, we examine the determinants of bank holdings of domestic sovereign debt with a panel dataset of 295 banks in 35 countries between 2002 and 2013. The findings indicate that the structure of bank ownership (domestic, foreign, or government ownership), the quality of governance, and the level of financial development of the countries in which banks operate all determine the level of home bias. Specifically, we find that domestic banks tend to hold more domestic sovereign debt relative to their foreign counterparts. We also provide evidence that home bias is even stronger when the domestic bank is controlled by its government. Moreover, home bias increases when government bonds are more risky, home governments are less effective, and when banking systems are less financially developed. Overall, we find that banks’ home bias in holding sovereign debt is an international phenomenon that is determined by both bank- and country-specific factors.
Highlights
The sovereign debt crisis erupted in Europe after the collapse of Lehman Brothers
We seek to answer the following questions: Are banks owned by foreign entities less prone to home bias in their bond holdings? Does government ownership of banks affect the holdings of domestic sovereign debt? Do government-owned banks tend to buy more domestic sovereign bonds when credit conditions deteriorate? Does a country’s level of financial system development, governance, and control over corruption affect the banks’ holdings of domestic sovereign debt? Is the home bias in European banks a unique phenomenon or can we observe it internationally?
We investigate whether home bias and ownership structure are related, since governments can use moral suasion to ensure that banks, especially domestic banks, participate in new issues of sovereign bonds
Summary
The sovereign debt crisis erupted in Europe after the collapse of Lehman Brothers. This crisis has ignited research interest in the behavior of sovereign debt holders. Acharya et al (2015) provide a theoretical model for the feedback loop between the credit risks of sovereign debt and banks They use data on bank sovereign holdings from the Eurozone stress tests announced in 2010 to find a substantial home bias in banks’ holdings of domestic sovereign bonds. Similar to other studies in the literature, we investigate whether banks’ holdings of domestic sovereign bonds occur because of bank-specific factors, such as ownership structure (domestic, foreign, or state ownership) Another contribution is that the country’s governance as well as the banking sector’s development and capital market conditions are significant determinants of home bias in banks’ bond holdings.
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