3 Issuing costs of state guaranteed bonds - Financial Risk and ...

3 Issuing costs of state guaranteed bonds
most common structure of this latter fee is to include a fixed component of 50bps plus a variable
component related to bank risk (based on historical CDS spreads or credit ratings). 6
For the purposes of this study, the term issuing cost will focus on returns or yields to SG and non-
SG bonds and omit fees. Our approach is to estimate a model of issuing costs in order to
determine the market value of a state guarantee in terms of issuing costs, controlling for other
factors.
This choice is driven by the considerations presented below.
Omission of guarantee fees
Assessing the effectiveness of state guarantees in restoring the proper functioning of wholesale
funding markets (and related policy questions) requires an understanding of how state guarantees
influenced choices made by investors to supply funds and by banks to demand funds.
Investor decision-making is driven by returns to (or issuing costs of) SG and non-SG bonds only,
hence these are considered in isolation of fees banks face, including guarantee fees.
Data on differences in returns between SG and non-SG bonds show how well SG and non-SG
bonds attract investor funds. Or, put in another way, returns to SG and non-SG bonds are the
relevant issuing costs because they capture the factor on which investor choices to participate or
withdraw from wholesale funding markets are made. Fees charged to banks for bringing bonds to
market and for guarantees, in the case of SG bonds, have no direct impact on investor decisionmaking.
Bank decision-making is driven by issuing costs and fees. However, these choices cannot be
analysed because data on returns to SG and non-SG bonds in a counterfactual world in which state
guarantee schemes are not present do not exist.
In theory, guarantee fees could have mooted the impact of state guarantees on wholesale funding
markets if they discouraged credit constrained banks from taking up state guarantees and/or
encouraged non-credit-constrained banks to issue SG bonds instead of non-SG bonds.
Empirically, however, these bank choices cannot be observed directly because the presence of
state guarantees prevents us from uncovering what issuing costs of SG and non-SG bonds would
have been in the absence of state guarantees.
Indirectly, the question of how effectively state guarantees encouraged credit constrained banks
to take-up SG bonds and discourage non-credit-constrained banks can be observed through bank
outcomes such as lending behaviour.
Both credit constrained and unconstrained banks may be willing to take-up SG bonds. However,
while constrained banks could be expected to use state guarantees to expand lending activity,
unconstrained banks would be more likely to use SG bonds to substitute for other sources of
6 Section 3 describes the nature of these fees and size of actual charges made to banks.
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