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

3 Issuing costs of state guaranteed bonds
external finance. Empirically, these differences can be observed and indicate whether credit
constrained banks had selected into guarantee schemes or not.
Anecdotally, the general perception is that limited activity on wholesale funding markets reflected
banks' inability to access wholesale funding at all. If this is really the case, banks were not,
therefore, substituting SG bonds for non-SG bonds they could have been issuing.
Further, Acharaya and Sundaram (2009) show that guarantee fees represented a small tax rather
than a subsidy to banks taking up SG bonds. This further supports the notion that banks did not
have an incentive to take-up SG bonds if alternative wholesale funding options were available to
them.
To summarise, empirically 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 choices made
by banks to demand funds. Investor decision-making is driven by returns to SG and non-SG bonds
only, hence these are considered in isolation of fees banks face. Bank decision-making is driven by
returns (or issuing costs) and fees. However, these cannot be analysed because data on issuing
costs in the absence of state guarantee schemes is unavailable.
Credit spreads
Issuing cost is generally expressed as the difference between the returns or yield investors can
expect from a given SG/non-SG bond and a comparable benchmark security/curve that is
(assumed) risk free. This difference captures the additional return investors must be paid in order
to compensate them for assuming the additional credit risk embedded within an SG/non-SG bond
and is known as the credit spread.
From a policy perspective, credit spreads provide a highly valuable measure of issuing cost. This is
because they also summarise market perceptions of the credit risk of banks, which is fundamental
to understanding the role state guarantees played in stimulating activity on wholesale funding
markets.
Practically, credit spreads allow for the relative value of SG and non-SG bonds to be compared
within and across banks through a single statistic.
The spread to Treasury at issue, for instance, on the $1bn SG bond issued by Barclays Bank in
March 2009, for instance, was 149bps (or 1.49%), implying that investors as a group required an
additional $14,900,000 per annum compared to what they would require in order to invest in a
comparable Treasury security on the day of issue. Meanwhile, the spread to Treasury at issue on
the $1bn SG bond issued by Swedbank was 119.3bps, implying that the difference in credit risk
between the two SG bonds amounted to 29.7bps (149bps – 119.3bps) or $2,970,000 per annum.
Further, credit spreads summarise a range of factors that influence credit risk, which can be
isolated empirically to consider policy questions such as the impact of state guarantees on issuing
cost. Continuing with the examples of the Barclays Bank and Swedbank bond issues described
above, several comments regarding the sources of differences in credit risk can be made. For
example, firstly, the Swedbank SG bond was issued in Jun 2009 when wholesale funding markets
were, at least to some degree, different to March 2009. Secondly, the maximum tenor was four
31