Thursday, 25 March 2010: 14:50
In response to the financial crisis, and especially from mid-September 2008 following the collapse of Lehman Brothers, the authorities of almost all industrial and emerging economies set up a number of schemes in support of banks and other financial institutions. In particular, governments provided explicit guarantees against default on bank de bt and other non-de posit liabilities. These measures helped banks maintain access to medium-term funding at reasonable cost, offsetting the drying-up of alternative sources of funding (such as securitisation) and the increase in credit spreads. The adoption of debt guarantee programmes was coordinated and synchronised across countries, allowing guaranteed bond issuance to become soon a key source of bank funding and leading to the creation of a new segment of the fixed income market, with a non negligible size. In the period since October 2008 the issuance of guaranteed bonds in all regions accounted for a large share of total issuance by banks, with peaks of more than 60 per cent in November and December 2008 followed by a gradual decline in the first (40 per cent) and the second quarter (25 per cent) of 2009. As of end-September 2009, over 1.100 bonds totalling around the equivalent of €760 billion had been issued in G10 countries by roughly 180 financial institutions.
In the paper we describe the evolution of this new segment of corporate bond market, highlighting some key characteristics and assessing possible inefficiencies. In particular, we focus on a striking feature which becomes apparent as one compares the spread at launch of guaranteed bonds (i.e. the cost for the issuer), namely the sharp tiering across countries. Banks with the same rating but different nationality have paid markedly different spreads. In some cases, banks with a better rating have paid much larger spreads than banks with a lower rating. We show that these differences can be quite large. For example, for bonds issued by banks rated A, the range is close to 80 basis points (from 20 basis points for some US banks to 100 basis points for some Spanish banks).
An econometric analysis based on a cross-country regression on over 450 bond issues indicates that the differences between the spreads paid by individual banks at launch reflect to a large extent the characteristics of the sovereign guarantor (such as its rating or the timeliness of payments in case of default of the issuer), whereas bank-specific factors (e.g. its credit risk) and issue-specific factors (e.g. volume and maturity) play only a minor role. This finding represents an example of the distortions that may stem from government intervention, because it implies that “weak” banks from “strong” countries may have access to cheaper funding than “strong” banks from “weak” countries. Such a pricing of risk is inconsistent with a “level playing field” and leads to an inefficient allocation of resources.
In the paper we describe the evolution of this new segment of corporate bond market, highlighting some key characteristics and assessing possible inefficiencies. In particular, we focus on a striking feature which becomes apparent as one compares the spread at launch of guaranteed bonds (i.e. the cost for the issuer), namely the sharp tiering across countries. Banks with the same rating but different nationality have paid markedly different spreads. In some cases, banks with a better rating have paid much larger spreads than banks with a lower rating. We show that these differences can be quite large. For example, for bonds issued by banks rated A, the range is close to 80 basis points (from 20 basis points for some US banks to 100 basis points for some Spanish banks).
An econometric analysis based on a cross-country regression on over 450 bond issues indicates that the differences between the spreads paid by individual banks at launch reflect to a large extent the characteristics of the sovereign guarantor (such as its rating or the timeliness of payments in case of default of the issuer), whereas bank-specific factors (e.g. its credit risk) and issue-specific factors (e.g. volume and maturity) play only a minor role. This finding represents an example of the distortions that may stem from government intervention, because it implies that “weak” banks from “strong” countries may have access to cheaper funding than “strong” banks from “weak” countries. Such a pricing of risk is inconsistent with a “level playing field” and leads to an inefficient allocation of resources.