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Lender of last resort versus buyer of last resort: The impact of the European Central Bank actions on the bank-sovereign nexus

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  • Acharya, Viral
  • Pierret, Diane
  • Steffen, Sascha

Abstract

In summer 2011, elevated sovereign risk in Eurozone peripheral countries increased the solvency risk of Eurozone banks, precipitating a run on their short-term debt. We assess the effectiveness of different European Central Bank (ECB) interventions that followed - lender of last resort vs. buyer of last resort - in stabilizing the European financial sector. We find that (i) by being lender of last resort to banks via the long-term refinancing operations (LTRO), ECB temporarily reduced funding pressure for banks, but did not help to contain sovereign risk. In fact, banks of the peripheral countries used the public funds to increase their exposure to risky domestic debt, so that when solvency risk in the Eurozone worsened the run of private short-term investors from Eurozone banks intensified. (ii) In contrast, ECB's announcement of being a potential buyer of last resort via the Outright Monetary Transaction program (OMT) significantly reduced the bank-sovereign nexus. The OMT increased the market prices of sovereign bonds, leading to a permanent reversal of private funding flows to Eurozone banks holding these bonds.

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  • Acharya, Viral & Pierret, Diane & Steffen, Sascha, 2016. "Lender of last resort versus buyer of last resort: The impact of the European Central Bank actions on the bank-sovereign nexus," ZEW Discussion Papers 16-019, ZEW - Leibniz Centre for European Economic Research.
  • Handle: RePEc:zbw:zewdip:16019
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    Cited by:

    1. Viral V. Acharya & Sascha Steffen, 2016. "Capital Markets Union in Europe: Why other Unions must lead the Way," Swiss Journal of Economics and Statistics (SJES), Swiss Society of Economics and Statistics (SSES), vol. 152(IV), pages 319-329, December.
    2. Carla Soares & Diana Bonfim & Nuno Alves, 2016. "Surviving the perfect storm: the role of the lender of last resort," Working Papers w201617, Banco de Portugal, Economics and Research Department.
    3. van Riet, Ad, 2017. "Addressing the safety trilemma: a safe sovereign asset for the eurozone," ESRB Working Paper Series 35, European Systemic Risk Board.
    4. Cifarelli, Giulio & Paladino, Giovanna, 2020. "A non-linear analysis of the sovereign bank nexus in the EU," The Journal of Economic Asymmetries, Elsevier, vol. 21(C).
    5. Pagano, Michael S. & Sedunov, John, 2016. "A comprehensive approach to measuring the relation between systemic risk exposure and sovereign debt," Journal of Financial Stability, Elsevier, vol. 23(C), pages 62-78.

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    More about this item

    Keywords

    money market funds; repos; bank risk; sovereign debt; ECB;
    All these keywords.

    JEL classification:

    • G01 - Financial Economics - - General - - - Financial Crises
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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