28 Mar 2018

Domestic banks as lightning rods?

Home bias during the eurozone crisis

Orkun Saka

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European banks have been criticized for holding excessive domestic government debt during economic downturns, which has been interpreted as indicative evidence of moral suasion. By using a novel bank-level dataset covering the entire timeline of the eurozone crisis, I first re-confirm that the crisis led to the reallocation of sovereign debt from foreign to domestic banks. This reallocation was only visible for banks as opposed to other domestic private agents and it cannot be explained by the banks’ risk-shifting tendency. In contrast to the recent literature focusing only on sovereign debt, I show that banks’ private sector exposures were (at least) equally affected by a rise in home bias. Finally, I propose a new debt reallocation channel based on informational frictions and show that crisis-country debt was not only reallocated to domestic banks, but also to the informationally closer foreign banks. My results imply that informational asymmetries among banks played a key role in the recent fragmentation across eurozone debt markets.

JEL classification: F21, F34, F36, G01, G11, G21.
Keywords: Home bias; Information asymmetries; Eurozone crisis; Sovereign debt

Orkun Saka is a financial economist by training and a Postdoctoral Research Fellow at the London School of Economics and Political Science (LSE).

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