Do banks with a covered bond program in Europe take advantage of the new European regulation?

Covered bonds have been a crucial part of the European banking machinery for many years. They represent the link between banks’ funding strategies and the capability of originating high quality assets, which in turn enable cost-efficient funded lending to the real economy. Following the “Capital Markets Union Action Plan”, an important step forward to strengthen capital markets and investment in the European Union (EU) was the March 2018 issue of a proposal by the European Commission for a directive on covered bonds (CBs). This proposal lays down the conditions that these bonds have to respect in order to be recognized under EU law. It also invigorates investor protection by imposing specific supervisory duties. Until now the country framework has relied on principle-based EU regulation focusing on core elements of the covered bond regulatory treatment, whereas the actual implementation has been left at the national level, resulting in different national approaches as regards key technical issues (Chesini, Tamisari, 2009). The Commission proposes to harmonize national rules in the issuance of these securities, by providing common definitions, characteristics and rules with a view to the use of a European trademark. In this paper we intend to discover which countries might be the most penalized by compliance with the new future directive. Beyond this preliminary analysis of different CB regulations, we explore the different uses of these financial instruments by banks and also the various costs of issuance for banks. The CB price data are from Bloomberg and the bank balance sheets which issued CBs come from the Orbis Bureau van Dijk database. The features of our dataset and the relationships to be tested require the adoption of the generalized least squares (GLS) model with random effects and robust standard errors. Our quantitative analyses are conducted with Stata. We found differences in the usage of the CBs in different countries and we are able to understand when banks decide to issue CBs instead of other asset backed securities. We confirm that banks are more likely to use CBs to help with liquidity needs while mortgage-booked securities are associated with risk management and agency problems (Carbo Valverde, Rodriguez-Fernandez and Rosen, 2013). We show how regulation has been relevant in the growth of the markets for CBs. Finally, movements in CB prices permit analysis of the credit developments of the underlying issuer and the quality of its mortgage portfolio.