Long-Term Bank Funding Cost: Does Sovereign Matter?

Abstract

We analyze the long-term funding costs faced by banks from US, UK and euro-area on the international bond market with a focus on the value of implicit and explicit public guarantees. By looking at the risk-premia at issuance on 5,500 bonds, we find that: i) both explicit guarantees as well as sovereign creditworthiness have a substantial effect on the cost of bonds; ii) large institutions enjoy lower issuance costs, most likely due to the too-big-to-fail safety net; iii) since the onset of the global financial crisis, systemic banks (the so called G-SIFIs) underwent an enhanced market discipline paying an additional premium on new bond issuances. In particular, we show that non AAA-rated governments add a burden to the cost of debt issuance by the domestic banking system. This implicit negative support intensified in the most acute phase of the euro-area sovereign debt crisis: we estimate that the absence of the backing of an AAA-rated government amounted, ceteris paribus, to an average increase of 150bp in the cost paid by banks when issuing unsecured bonds in 2011. However, once we restrict the sample to banks for which CDS spreads are priced in the market – usually larger institutions which are more involved in the issuance activity – we find that the bond premium reflects more closely the characteristics of each institution (soundness and creditworthiness), with the role of government somewhat reduced. By distinguishing between banks’ absolute size and systemic relevance, we find that financial investors were able to disentangle the two issues. Or results suggest that the larger the magnitude of the balance sheet the lower the premium paid at launch on bonds, which in turn suggests that the safety net benefits granted to too-big-to-fail institutions encompass also lower funding costs on the primary bond market. At the same time, we find that there are matters of concern regarding the systemic relevance of financial institutions: their involvement in complex derivative trades and their business model have made them less transparent and less easy to price. In this respect we find evidence of enhanced market discipline: since the onset of the global financial crisis systemically important banks – which before the crisis were enjoying a reduction in the spread – paid, ceteris paribus, a larger premium of around 50 basis points on their bond issuance.