Sovereign Exposures of European Banks: It Is Not All Doom

We investigate whether sovereign bond holdings of European banks are determined by a risk-return trade-off. Using data between 2011 and 2018 for 75 European banks, we confirm that banks exhibited risk-taking behavior during the sovereign debt crisis, e.g., due to moral suasion. In the period 2015-2018, however, banks' investments in sovereign bonds are characterized by sound risk-return considerations, suggesting a lessening of the doom loop. This result is mainly driven by banks in the core European countries, as banks in the GIPS countries do not exhibit such behavior, nor do they avoid riskier bonds following the sovereign debt crisis.

Automated summary

This study examines whether European banks' holdings of sovereign bonds are influenced by the risk-return trade-off. The findings reveal that during the sovereign debt crisis, banks exhibited risk-taking behavior due to moral suasion. However, in the period 2015-2018, banks' investments in sovereign bonds were driven by sound risk-return considerations, indicating a reduction in the doom loop. This trend was primarily observed among banks in core European countries, while banks in GIPS countries did not show similar behavior.