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

3 Issuing costs of state guaranteed bonds
In general, the higher the actual issuing cost of a bond, the larger the impact of a state guarantee
in reducing it. Specifically, bond issues in the 60-90th percentile have an issuing cost that is in the
region of 100bps lower than without the state guarantee ceteris paribus.
The distribution suggests, therefore, that state guarantees benefit the banks and bond issues that
are regarded by investors as posing more credit risk. From a policy perspective, this finding is
interesting in that state guarantees have the greatest impact (insofar as the reduction in issuing
costs is largest) amongst the banks that had greatest difficulty in accessing wholesale funding.
However, it must also be noted that at each issuing cost quantile, the impact of state guarantees is
heterogeneous. For instance, while the average impact in the 60-90 th percentile was
approximately 100bps, the 95% upper and lower confident intervals were 160bps and 60bps,
respectively.
3.5.5 Impacts by guarantor
The motivation for analysing impacts of state guarantees by guarantor relates to the concern that
differences in the design of Member States' guarantee schemes caused the efficacy of state
guarantees to vary across the European Union.
Alternatively/in addition to this, it may be the case that differences in sovereign risk have been
more important in determining the impact of state guarantees than issue risk. This relates to the
earlier discussion regarding the relationship between sovereign ratings and issuing costs in Section
3.4. There we found that the relationship between sovereign ratings and issuing costs was
stronger than the relationship between bond ratings and issuing costs (see Figure 14). Therefore,
the standing of the guarantor appeared to be more important than that of the bank in bond
pricing. This observation is corroborated by existing literature that suggests that "strong" Member
States have been propping up "weak" financial institutions (see Levy and Schich, 2010; and Panetta
et al., 2009).
The overarching concern is the effect state guarantees may have had on competition through
financial market fragmentation. Namely, if banks are limited in their ability to access state
guarantees to a single or a subset of guarantors and the effectiveness of guarantees varies
systematically by guarantor, we can conclude that financial markets have become relatively more
fragmented than in the absence of state guarantee schemes.
However, on balance the evidence does not suggest financial market fragmentation to any
meaningful extent.
We adopted the main empirical specification to test the hypothesis that state guarantees from
particular guarantors had an effect on issuing costs additional to the effect expected by state
guarantees generally through differences in sovereign risk (captured by the sovereign CDS). 12 The
estimation results of this issuing cost model show no statistically significant effect of state
guarantees from particular guarantors on issuing cost, as shown in column 2 of Table 8 (page 61).
12 An interaction term between use of state guarantee (GUARANTEEi) and sovereign CDS (SOVit) was added to the main empirical
specification. In addition to any effect of state guarantees on issuing cost that applies on average, the interaction term demarcates
any additional effects due to the sovereign risk of particular guarantors.
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