March 2019 issue contents
Home Bias in Bank Sovereign Bond Purchases and the Bank-Sovereign Nexus

We study whether a pre-existing link between bank and sovereign credit risk biased euro-area banks' sovereign debt portfolio choices at the turn of 2011-12, a period of exceptional

increases in their domestic sovereign bond holdings. When bank and sovereign creditworthiness are correlated and sovereign credit risk is elevated, incentives to "shift risk" may render domestic sovereign bonds more attractive than other liquid assets. By investing in domestic government bonds, banks can earn the full risk premium while the risk itself is largely borne by their creditors, as it materializes in states of the world where the banks are likely to be insolvent anyway. Using a bank-level data set, we find evidence that this mechanism can explain a significant part of the purchases of domestic sovereign bonds in the final quarter of 2011 and the first quarter of 2012.