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What Drives Sovereign Debt Portfolios of Banks in a Crisis Context?

In this paper we study determinants of sovereign portfolios of Spanish banks over a long time-span, starting in 2008. Our findings challenge the view that banks engaged in moral hazard strategies to exploit the regulatory treatment of sovereign exposures. In particular, we show that being a weakly capitalized bank is not related to higher holdings of domestic sovereign debt. While a strong link is present between central bank liquidity support and sovereign holdings, opportunistic strategies or reach-for-yield behavior appear to be limited to the non-domestic sovereign portfolio of well-capitalized banks, which might have taken advantage of their higher risk-bearing capacity to gain exposure (via central bank liquidity) to the set of riskier sovereign bonds. Furthermore, we document that financial fragmentation in EMU markets has played a key role in reshaping sovereign portfolios of banks. Overall, our results have important implications for the ongoing discussion on the optimal design of the risk-weighted capital framework of banks.