Capital Requirements for Government Bonds - Implications for Financial Stability

Transcription

1 Capital Requirements for Government Bonds - Implications for Financial Stability André Sterzel Ulrike Neyer Heinrich Heine University Duesseldorf Monetary Policy Economic prospects for the EU - Challenges for economic policy until the end of decades Duesseldorf 2016, September 23 André Sterzel Capital Requirements for Government Bonds 1 / 16

2 Motivation next preferential regulatory treatment of sovereign debt, zero risk weight large sovereign debt holdings of banks chart reinforcing feedbacks between sovereigns and banks sovereign assets are no longer risk-free phasing out of the preferential treatment chart André Sterzel Capital Requirements for Government Bonds 2 / 16

3 How Much Sovereign Debt is Held by European Banks? non-stressed stressed Source: SDW. * Note: The stressed euro area countries are Greece, Ireland, Italy, Portugal and Spain. ** Note: The non-stressed euro area countries are Austria, Belgium, Finland, France, Germany and the Netherlands. Figure: Total euro area sovereign debt holdings of MFIs as a percentage of total assets Source: ESRB (2015) return André Sterzel Capital Requirements for Government Bonds 3 / 16

4 Research Question How do capital requirements for government bonds influence: banks balance sheet structure financial stability Capital regulation regimes Capital ratio with zero risk weight for government bonds Capital ratio with positive risk weight for government bonds André Sterzel Capital Requirements for Government Bonds 4 / 16

5 Results Banks balance sheet structure less investment in sovereign debt more equity in the banking system more investment in loans Financial stability weaker contagion lower government bond losses higher liquidity provision by the central bank André Sterzel Capital Requirements for Government Bonds 5 / 16

6 Literature Contagion between sovereign and the banking sector Acharya et al. (2014) Acharya and Steffen (2013), Bolton and Jeanne (2011), Cantero-Saiz et al. (2014), Gennailoli et al. (2014), Bruyckere et al. (2013), Battistini et al. (2014) Capital Regulation Blum (1999), Hyun and Rhee (2011), Glasserman and Kang (2014) Model framework - financial stability Allen and Gale (2005), Allen and Gale (2000), Allen and Carletti (2006), Heyde and Neyer (2010). André Sterzel Capital Requirements for Government Bonds 6 / 16

7 Outline 1 Introduction 2 Model Framework 3 Banks Investment Behaviour 0% Risk Weight for Sovereign Bonds Positive Risk Weight for Sovereign Bonds 4 Financial Stability Government Bond Shock Central Banks as Lender of Last Resort 5 Conclusion André Sterzel Capital Requirements for Government Bonds 7 / 16

8 Framework three dates t=0,1,2 early consumers γ, late consumers (1 γ) banking sector: maximize depositors utility E(U) assets: short-term assets, government bonds, loans function bank s liability side: equity capital e 0 (costly), deposits D = 1 (exogenously) idiosyncratic liquidity uncertainty early banks with only early depositors late banks with only late depositors interbank market for government bonds, t=1 André Sterzel Capital Requirements for Government Bonds 8 / 16

9 Timeline equilibrium price government bond government bond demand government bond supply interbank market for government bonds André Sterzel Capital Requirements for Government Bonds 9 / 16

10 Capital Regulation Approaches Capital adequacy ratio with a 0% risk weight for sovereign debt capital ratio equity capital risk-weighted loans Capital adequacy ratio with positive risk-weights for sovereign debt capital ratio equity capital risk-weighted: loans; sovereign assets André Sterzel Capital Requirements for Government Bonds 10 / 16

11 Loans Balance Sheet Structure - Investment Shift Capital Adequacy Ratio with pos. Risk Weight A Short-term Asset Government bond Loans Equity Capital Deposits L results André Sterzel Capital Requirements for Government Bonds 11 / 16

12 Government Bond Shock,, small shock large shock André Sterzel Capital Requirements for Government Bonds 12 / 16

13 Central Banks as Lender of Last Resort early banks are illiquid/ insolvent central bank provides liquidity against sound assets capital requirements for government bonds less sovereign debt holdings (lower losses) more loans (more liquidity from the central bank) better shock absorbing capacity André Sterzel Capital Requirements for Government Bonds 13 / 16

14 Results ß ß ß ß ß ß André Sterzel Capital Requirements for Government Bonds 14 / 16

15 Conclusion How do capital requirements for government bonds influence: Banks balance sheet structure less investment in sovereign debt more equity in the banking system more investment in loans Financial stability weaker contagion lower government bond losses higher liquidity provision by the central bank André Sterzel Capital Requirements for Government Bonds 15 / 16

16 Thanks for your attention!

17 Literature 1 Acharya et al. (2014). A Pyrrhic Victory? Bank Bailouts and Sovereign Credit Risk, The Journal of Finance 69.6, pp Acharya and Steffen (2015). The Greatest Carry Trade Ever? Understanding Eurozone Bank Risks, Journal of Financial Economics pp Allen and Carletti (2006). Credit Risk Transfer and Contagion, in: Journal of Monetary Economics 53, pp Allen and Gale (2000). Financial Contagion, in: Journal of Political Economy 108, pp Allen and Gale (2005). Systemic Risk and Regulation, in: Cary, M., Stulz, R. (Eds.) Risk of Financial Institutions, NBER.

18 Literature 6 Battistini et al. (2014). Systemic Risk, Sovereign Yields and Bank Exposures in the Euro Crisis, in: Economic Policy 29.78, pp Blum (1999). Do Capital Adequacy Requirements Reduce Risks in Banking?, in: Journal of Banking and Finance 23.5, pp Bolton and Jeanne (2011). Sovereign Default Risk and Bank Fragility in Financially Integrated Economies, in: IMF Economic Review 59.2 pp Bruyckere et al. (2013). Bank/Sovereign Risk Spillovers in the European Debt Crisis, in: Journal of Banking & Finance pp Cantero-Saiz, Maria et al. (2014). Sovereign Risk and the Bank Lending Channel in Europe, in: Journal of International Money and Finance 47, pp

19 Literature 11 Gennaioli, Nicola et al. (2014). Sovereign Default, Domestic Banks, and Financial Institutions, in: The Journal of Finance 69.2, pp Glassermann and Kang (2014). Or Forum - Design of Risk Weights. Operations Research pp Hyun Rhee (2011). Bank Capital Regulation and Credit Supply, in: Journal of Banking and Finance 35, S Neyer and Heyde (2010). Credit Default Swaps and Stability of the Banking Sector, in: International Review of Finance 10 (1), pp

20 Backup - Are European Government Bonds Safe? Figure: Yields of Ten-Year Euro Area Sovereign Debt Source: ESRB (2015), pp. 85. return

21 Government Bond Demand - Late Banks Late banks purchase government bonds if ln(p) + βln(h) + (1 β)ln(l) ln(1) = 0. Maximum price late banks are willing to pay for government bonds p max = e βln(h)+(1 β)ln(l). Government bond demand function y D = { 0.5 x p if p p max, 0 if p > p max. return

22 Government Bond Supply - Early Banks Early Banks have to sell their total amount of government bonds Government bond supply function y S = 0.5y. return

23 Interbank Market for Government Bonds Figure: IBM for government bonds at date 1 return

24 A Banks Optimization Problem E[U] =0.5ln(c 1 ) + 0.5[αβ ln(c 2Hh ) + α(1 β) ln(c 2Hl ) + (1 α)β ln(c 2Lh ) + (1 α)(1 β) ln(c 2Ll )], max s.t (1) budget constraint (2) non-negativity constraint (3) investors compatibility constraint c1 = x + y p ( ) x c2hh = uh + p + y h e 2Hh. return

25 Optimization Problem of the Bank - no Regulation Numerical example Government bonds h = 1.3 β = 0.98 E(S) = 1.28 l = 0.3 (1 β) = 0.02 Loans H = 1.54 α = 0.93 E(K) = 1.28 L = 0.25 (1 α) = 0.07 Capital costs ρ = 1.5 results A L x % e % y % D % u % % %

26 Capital Regulation Approaches Formula Risk weights CAR1 LR CAR2 e 0 u e 0 x+y+u e 0 u+0.05y u = 100% u = 100% y = 0% y = 5% Optimal ratio 48.33% 7.86% 20% higher ratio 57.99% 9.43% 5% risk weight for government bonds 57.99%

27 Balance Sheet Structure - Investment Shift CAR1, 0% risk weight government bonds A L x % e % y % D % u % % % e 2Hh CAR2, 5% risk weight government bonds A L x % e % y % D % u % % % e 2Hh return

28 Interbank Market for Government Bonds - Shock Government Bond Demand p max = e βln(h)+(1 β)ln(l) with: p max < p max y D = Government Bond Supply { 0.5 x p if p p max, 0 if p > p max. y S = y S = 0.5y. return

29 Government Bond Shock - Small Shock return

30 Government Bond Shock - Large Shock return

31 Market Clearing Condition Government Bond Market p = 1 Investment decision at date 0 p > 1: no bank would invest in the short asset can not be an equilibrium price p < 1: no bank would invest in government bonds can not be an equilibrium price the only equilibrium price is p = 1 p max 1 is satisfied by the assumption E(S) 1

32 Backup - CAR 0% risk weight for sovereign bonds Optimization problem of the bank E[U] = 0.5ln(c 1 ) + 0.5[ ln(c 2Hh ) ln(c 2Hl ) ln(c 2Lh ) ln(c 2Ll )] max s.t x + y + u = 1 + e 0 x, y, u, e 0, e 2Hh, e 2Hl, e 2Lh, e 2Ll 0 0.5[ u u]+ 0.5[0.9114e 2Hh e 2Hl e 2Lh e 2Ll ] = 1.5 e 0 e 0 u =

33 Backup - CAR 5% risk weight for sovereign bonds Optimization problem of the bank E[U] = 0.5ln(c 1 ) + 0.5[ ln(c 2Hh ) ln(c 2Hl ) ln(c 2Lh ) ln(c 2Ll )] max s.t x + y + u = 1 + e 0 x, y, u, e 0, e 2Hh, e 2Hl, e 2Lh, e 2Ll 0 0.5[ u u]+ 0.5[0.9114e 2Hh e 2Hl e 2Lh e 2Ll ] = 1.5 e 0 e 0 u y =