The Fire-Sale Channels of Universal Banks in the European Sovereign Debt Crisis

Abstract

We use a unique security-level data set to analyze whether German banks use their customer portfolios and affiliated mutual funds as an exit channel for risky sovereign bonds in the European sovereign debt crisis. Matching banks' proprietary holdings with the holdings of their funds and their retail customers for the period 2009-2016 at the security level, we find evidence that banks sold off risky Euro area sovereign bonds to both their retail customers and their affiliated mutual funds during the European sovereign debt crisis. For the mutual funds, the sell-offs were more pronounced to public funds compared to special funds dedicated to institutional investors. Overall, this enabled banks with affiliated mutual funds to sell off larger amounts of their risky sovereign bond holdings, while bank-affiliated mutual funds acquired more risky sovereign bonds compared to their unaffiliated peers. Our findings have important implications. First, they suggest that there is a severe conflict of interest between banks’ own account trading and the asset and wealth management services they offer to retail investors, potentially calling for better consumer protection. At the same time our findings also show that the severity of fire-sale contagion depends on the organizational structure of the financial sector.

Keywords: Mutual funds, conflict of interest, sovereign debt, fire-sale contagion

JEL Classification: G21, G23, G28, G14