Series: Working Papers. 1843.
Author: Matías Lamas and Javier Mencía.
Topics: Government debt | Financial markets | Financial risks | Crisis | Basel Committee.
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Abstract
We study determinants of sovereign portfolios of Spanish banks over a long time-span, starting
in 2008. Our findings challenge the view that banks engaged in moral hazard strategies to
exploit the regulatory treatment of sovereign exposures. In particular, we show that being a
weakly capitalized bank is not related to higher holdings of domestic sovereign debt. While
a strong link is present between central bank liquidity support and sovereign holdings,
opportunistic strategies or reach-for-yield behavior appear to be limited to the non-domestic
sovereign portfolio of well-capitalized banks, which might have taken advantage of their higher
risk-bearing capacity to gain exposure (via central bank liquidity) to the set of riskier sovereign
bonds. Furthermore, we document that financial fragmentation in EMU markets has played a
key role in reshaping sovereign portfolios of banks. Overall, our results have important
implications for the ongoing discussion on the optimal design of the risk-weighted capital
framework of banks.