Banks may be under political influence when they buy their governments’ bonds. Who knew? From Tracy Alloway at blomberg.com:
“Correlation does not imply causation, but it does waggle its eyebrows suggestively and gesture furtively while mouthing ‘look over there,'” quipped the comic xkcd.
A new working paper by Filippo De Marco and Marco Macchiavelli is likely to raise many eyebrows as it makes the case that political suasion may have created the very thing that helped plunge the eurozone into crisis, using stress test data to argue that higher state ownership and the presence of politicians on bank boards are linked to lenders’ penchant for snapping up domestic government debt.
The tendency of European banks to accumulate government bonds issued by their own countries on their balance sheets — banks’ average ‘home’ exposure was a whopping 74 percent of total government debt holdings on the eve of the crisis in late 2010 — created the perfect path for sovereign stress to infect the financial system (and vice versa).
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The origins of this so-called sovereign-bank loop, or nexus, have since been the topic of much speculation with blame placed on everything from financial regulation that encourages banks to snap up government debt to the liquidity operations of the European Central Bank (ECB). Even five years on from the worst of the eurozone debt crisis, the debate is very much alive given current proposals to restrict the amount of government bonds on European bank balance sheets and in light of concerns over Italian financials, where domestic state debt accounts for a greater-than-eurozone-average proportion of lenders’ total assets.
The paper by De Marco and Macchiavelli, assistant professor of finance at Bocconi University and Federal Reserve Board economist respectively, mounts an altogether more punchy argument, asserting that European banks’ accumulation of domestic debt is decisively linked to political influence.
“Politics is at the root of the problem,” they write in the paper. “Many European banks are government–owned or have politicians sitting on the board of directors. These politicians may persuade the politically connected banks to finance national or local state borrowing by purchasing domestic government bonds.”
Banks owned by the domestic government or with former politicians on their board of directors appear to hold an outsized amount of their own country’s sovereign debt, the authors find, with a 1 percentage point increase in the share of politically-linked directors on a bank’s board associated with a jump in the ratio of domestic debt exposure versus total exposure of around 1 percent between 2010 and 2013, for instance.
The increase in home bias from the eurozone crisis and onwards has been particularly marked in Southern European countries compared with those in the North. Many cooperative and savings banks in the periphery have a simple business model — take in retail deposits and buy government bonds — that might naturally encourage such activity while coinciding with higher political involvement.
To continue reading: Politics May Have Helped Create Europe’s Sovereign-Bank Loop of Doom
