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Exporting sovereign stress: Evidence from syndicated bank lending during the euro area sovereign debt crisis

Alexander Popov Neeltje Van Horen

(European Central Bank) (De Nederlandsche Bank)

March 21st, 2014 Conference on „Bank performance, financial stability, and the real economy“

Disclaimer: These are our views and do not necessarily reflect those of the ECB, De Nederlandsche Bank, or the Eurosystem.

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New experience for Europe

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Motivation

• Strong impact of sovereign debt crisis on European financial system and real economy

• Consequences reach far beyond Europe’s borders

• “Sovereign debt crisis […] most immediate threat to global growth.” (IMF 2012)

• Real consequences through at least two channels

• trade linkages (consolidation of public finances weakening demand for imports)

• financial linkages (portfolio rebalancing by banks holding impaired sovereign bonds)

• Focus on latter

• effect of balance sheet exposure to impaired debt on domestic and foreign bank lending

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This paper

• Study the impact of exposure to impaired foreign (GIIPS) sovereign debt on lending

• focus on banks active in the syndicated loan market

• 34 banks domiciled in 11 non-GIIPS European countries

• Specifically we study

• impact on total amount of loans extended

• change in composition of loan portfolios (domestic vs. foreign)

• interaction with banks’ “carry trade”-type behavior from first stage of the crisis

• Effect of ECB’s asset purchase program (SMP)

• Make sure results are not affected by:

• other types of shocks to banks’ balance sheets

• unobservable time-invariant bank characteristics

• Identification: heterogeneity in bank exposures, common borrower

• 1 affected and 1 non-affected bank lending to the same borrower at the same time

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Why the syndicated loan market?

• Syndicated loan: a loan jointly extended by a syndicate of banks

• very large (median loan 150 mln. EUR)

• borrower can be a corporate, a bank, or a government entity

• World syndicated loan market important source of external finance for corporates

• 3.5 trillion EUR in 2007

• 250+ active banks

• 190+ borrower countries

• Accessibility and frequency

• publicly registered, covers all countries, universe of loans available (no sample selection concerns)

• available over long time period (1997 – this morning)

• Loan flows from individual banks to individual countries

• can exploit differences between banks w.r.t. to their exposure to impaired GIIPS debt

• can control for changes in credit demand and borrower quality

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Syndicated loan market, 2007:Q1-2011:Q4

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Syndicated loan market, 2007:Q1-2011:Q4

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Sovereign debt on banks’ balance sheets

• Basel II / CRD gives banks incentives to hold government debt on their portfolios

• risk weight on debt issued in domestic currency allowed to be 0%

• exposure to highly rated sovereigns exempt from 25% limit on large exposures

• “By 2016, the conditions for a new systemic crisis - this time sovereign - might be in place. What is unique is that, while defaults on sovereign debt occurred before Basel I and II, this time regulatory authorities are actively encouraging banks to take refuge in government debt. So why is the Basel Committee insisting on calling local-currency-denominated sovereign debt risk-free? I don’t know.”

M. Pomerleano, Financial Times, February 3, 2010

• Euro area banks hold sizeable amounts of debt issued by foreign euro area sovereigns

• 1/3 of overall exposure

• perverse post-Lehman effect (flight to safety)

• European banking market makes for an ideal set-up

• banks hold simultaneously German Bunds and GIIPS debt

• varying degrees of exposure to safe and impaired debt

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Link between sovereign debt and bank lending

• Exposure to foreign sovereign debt bank lending: two channels

• losses lead to weakening of the bank’s balance sheet and thus increase its riskiness

• adverse consequences for the cost and availability of funding

• sovereign debt often used as collateral

• reduced availability and eligibility of collateral, lower banks’ funding capacity

• Higher bank funding costs need to rebalance portfolio

• Increase in foreign sovereign debt risk reduction in supply of credit by banks

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• Loan growth at “Affected” banks lower after 2010:Q3 (while higher before)

• Affected banks = banks with above-median exposure to GIIPS debt

Impact GIIPS sovereign debt exposure on bank lending

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Preview of findings

• After 2010:Q3, affected banks increased lending less relative to non-affected banks

• by 23.5% in our preferred specification with bank and borrower-quarter fixed effects

• direct link between reduced creditworthiness of foreign sovereign debt and bank lending

• Reduction only in foreign lending (mostly US and GIIPS), domestic borrowers unaffected

• Results robust to alternating crisis period cut-offs and subsamples of host markets

• Tentative evidence that decline in lending has been arrested by:

• carry trade-type behavior by banks in 2010

• ECB’s asset purchase program in 2011

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Contribution to the literature

• Transmission (domestic and cross-border) of bank funding shocks

• Kashyap and Stein (AER 2000); Peek and Rosengren (AER 2000); Jimenez et al. (AER 2010);

Cetorelli and Goldberg (IMF ER 2011); De Haas and Van Horen (AER 2012); Giannetti and

Laeven (JFE 2012); Popov and Udell (JIE 2012); Schnabl (JF 2012); Ongena et al. (2013)

• Shocks to bank balance sheets and syndicated lending

• Ivashina and Sharfstein (JFE 2010); Santos (RFS 2011); Giannetti and Laeven (JFE 2012); De

Haas and Van Horen (RFS 2013)

• we examine a novel channel of transmission (exposure to foreign sovereign debt)

• Linkages between sovereigns and banks

• Angeloni and Wolff (2012); De Bruyckere et al. (2012)

• we identify spillovers from foreign sovereign debt to credit supply

• Sovereign creditworthiness and credit availability

• Arteta and Hale (JIE 2008); Bofondi et al. (2012); Correa et al. (2012); Ivashina et al. (2012)

• we exploit differences with respect to balance sheet exposures in multi-country setting

• we study impact of foreign sovereign debt exposure on both foreign and domestic lending

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• Diff-in-diff model:

• Lending: total syndicated loans issued by bank i to borrowers in country j during quarter t

• Post: dummy equal to 1 on and after 2010:Q4

• Affected: dummy equal to 1 if bank i is in top half of the sample in terms GIIPS exposure

• based on 2010:Q4 exposures

• Sample period: 2009:Q3 – 2011:Q4 (equal pre- and post- periods)

• Coefficient of interest:

• Captures change in lending from pre-treatment to post-treatment period

• for the group of affected banks relative to the group of non-affected banks

• If , lending increased less (decreased more) for the group of affected banks

Empirical methodology

1β

1 0β <

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• Diff-in-diff model:

• Bank balance sheet variables

• size, tier 1 ratio, share impaired loans, net income (1 year lagged)

• control for other types of shocks affecting concurrently bank’s balance sheets

• Bank fixed effects

• control for time-invariant bank-specific unobservable factors

• Country x quarter fixed effects

• control for (time-varying) changes in demand and borrower quality

• OLS, cluster by bank

Empirical methodology: Controls

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• 90 European banks participating in EBA stress tests

• 4 waves: March 2010, December 2010, December 2011, June 2012

• EBA reports total holdings of sovereign debt issued by 30+ countries

• focus on debt issued by 5 GIIPS countries + domestic exposure

• Use 2010:Q4 data to calculate exposures (in ratio to assets)

• Different exposures in robustness tests

• Exclude GIIPS banks

EBA data: Bank sovereign debt exposures

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• Degree to which bank i is exposed to GIIPS sovereign debt

• Affected: dummy variable equal to 1 if bank i is in top half of the sample

GIIPS exposure

{ }

x

where 2010 : 4 and

, , , ,

ikt ktit

k it

Debt Securities CDSGIIPS ExposureTotal Assets

t Q

k Greece Ireland Italy Portugal Spain

=

=

∈

∑

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Affected vs. non-affected banks: different in other ways?

Non-affected Affected

T-test of equal means

(p-value)Balance sheet

Assets (billion USD) 644.36 581.48 0.77Tier 1 ratio 11.62 10.54 0.21Impaired loans to assets 2.19 2.11 0.89Net income 0.00 -0.14 0.53

Syndicated lendingTotal lending (billion EUR) 6.62 8.27 0.58Share domestic lending 0.29 0.34 0.57Share GIIPS lending 0.03 0.11 0.01Share European lending (incl domestic)

0.67 0.61 0.45

Comparison affected and non-affected banks

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• Intersection of EBA and syndicated loans datasets (excluding GIIPS): 34 European

banks

• Domiciled in 11 non-GIIPS countries

• 71% of syndicated lending by European banks, 34% of total lending

• Unit of observation: bank – borrower country – quarter total lending

• For each loan all members known but often not exact loan shares

• split loan equally over syndicate member (De Haas and Van Horen AER 2012; RFS 2013)

• split 8108 syndicated loans in which at least one bank in our sample was active in 35295 loan portions

• use these loan portions to calculate quarterly (new) lending by bank i to country j

Data: Final

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Main result

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Main result

• Syndicated lending increased less for banks significantly exposed to impaired government

debt • economically large: lending increased 23.5 % less for affected banks in preferred specification

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Accounting for alternative explanations

• (1) Results may be demand-driven

• low-net worth firms may borrow from low-net worth banks

• (2) Affected banks may be exposed to sovereign debt crisis in different ways

• exposure to own government

• government support with strings attached during financial crisis

• subject to different trends

• exposure to debt securities issued by GIIPS corporates

• higher share GIIPS customers

• loans in currencies that depreciated against euro (mechanical decline in lending)

• Solution to (1): country-industry-quarter FEs, repeated borrowers

• Solution to (2): condition on all alternative factors

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Accounting for alternative explanations

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Accounting for alternative explanations

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Robustness

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Robustness

• Results robust to: • measuring exposure earlier, as a share of equity, or continuously

• comparing more extreme exposures

• exposure to Greece only

• alternative ways of measuring lending

• alternative sample period lengths

• alternative sub-samples of banks

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Portfolio reallocation

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Portfolio reallocation

• Domestic and core European lending not affected

• Largest reallocation away from marginal, GIIPS, and US markets

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Mechanisms affecting change in lending

• Banks did not immediately get rid of toxic debt when crisis started

• a number of (affected) banks in the sample increased GIIPS exposures between March and December 2010

• carry trade-type behavior by banks, hoping to pocket the spread between long-term bonds and short-term funding costs (Acharya and Steffen, 2012)

• effect on lending?

• ECB asset purchase program in late 2010 and 2011

• all but two banks in the sample decreased GIIPS exposures between December 2010 and December 2011

• most probably due to ECB’s asset purchase program

• effect on lending?

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Change in exposure and lending

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Change in exposure and lending

• Lower decline in lending for affected banks which increased exposures between March and

December 2010 (Optimists)

• Lower decline in lending for affected banks which decreased exposures more between

December 2010 and December 2011 (Big sale)

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• We study impact of exposure to GIIPS sovereign debt on lending by non-GIIPS banks

• Our results suggest that

• foreign sovereign stress has sizeable impact on bank lending

• effect not driven by

• changes in borrower demand/quality

• time invariant bank characteristics

• other types of shocks that concurrently affect bank’s balance sheets

• effect strongest for lending to marginal, US, and GIIPS markets

• evidence for link between lending and carry trade/asset purchases

• Aggregate effect unclear (firms can switch between lenders or types of finance)

• Result may not be general (syndicated lending: large banks & large borrowers)

Conclusions

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THANK YOU!