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

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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. 56
3 Issuing costs of state guaranteed bonds The lack of significance effect, however, may be due to lack of variation in the sovereign CDS variable (SOVi). In particular, as time-series data for the sovereign CDS variable was unavailable, an average of the period under study was used. This may not have fully captured the relationship between sovereign CDS spreads and issuing conditions at the time of each bond issue. For this and other reasons, we explored the impact of state guarantees by guarantor through another method as well. While the above analysis considers the relevance of sovereign risk to issuing costs, the approach below investigates the impact of particular guarantors on issuing costs in a broader way. 13 This covers an element of sovereign risk, as previously, but other aspects of the relationship between guarantors and issuing costs, for instance, the abovementioned differences in design of Member States' guarantee schemes. Figure 17 summarises the main findings of this investigation (while column 3 of Table 8 provides other details of estimation results). The bars show the impacts of state guarantees relating to particular guarantors relative to the average impact of 26.5 bps. The lines show the 95% confidence interval relevant to each of the impacts represented by the bars. 13 A vector of interaction terms between use of state guarantee (GUARANTEEi) and indicator variables identifying guarantors (GUARANTORi) were included in the main empirical specification. In addition to any effect of state guarantees on issuing cost that applies on average, the interaction term helps to identify any additional effects of particular guarantors. Results of this estimation are shown in Figure 17. 57
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Economic Papers are written by the
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Wherever possible London Economics
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Contents Page Annex 4 Results of di
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Tables, Figures & boxes Page Table
Page 10 and 11: Glossary vi Glossary BGN Bloomberg
Page 12 and 13: Executive summary Member States (Cy
Page 14 and 15: 1 Introduction 1 Introduction 1.1
Page 16 and 17: 1 Introduction 1.4 Research questi
Page 18 and 19: 1 Introduction analysis of the lat
Page 20 and 21: 2 Overview of state guarantee sche
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4 Impact of state guaranteed bonds
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5 Key empirical findings and polic
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References Acharya V.V. and Sundara
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Lando, D. (1997). 'Modeling Bonds a
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Annex 1 Eligibility criteria for st
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Annex 2 Comparison of SG and non-SG
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Annex 2 Comparison of SG and non-SG
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Annex 3 Analysis of missing issuin
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Annex 3 Analysis of missing issuing
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Annex 3 Analysis of missing issuing
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Annex 4 of diagnostic tests of issu
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Annex 4 of issuing cost model Figur
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Annex 5 -over model Annex 5 Results
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Annex 5 -over model Figure 25: Anal
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Annex 6 Availability of bank data A
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Annex 6 Availability of bank data T
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Annex 7 Linking Bloomberg and Banks
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Annex 8 Investigation of estimation
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