European banks US dollar liabilities: beyond the covered interest parity

Abstract

This article provides an update of the determinants of dollar-denominated long-term debt issuance by euro area banks, with a particular focus on deviations from Covered Interest Parity (CIP). These deviations, which have become more common since the global financial crisis, may have contributed to the so-called “covered cost savings” for banks issuing in US dollars at different moments in time. In contrast, negative savings may have deterred issuance in this currency during other periods. Since 2015, the relationship between covered cost savings and US dollar issuance seems to have weakened although “opportunistic” issuance may have persisted. We also document that recent regulatory reforms have enhanced the issuance of subordinated and other specific forms of longterm debt by euro area banks. These banks may have been incentivized to issue these bonds in US dollar, given the traditionally deep and wide US dollar investor base (i.e. strategic issuance). In addition to this, we investigate the possible reasons for CIP deviations as measured by the cross-currency basis swap. We conclude by analyzing possible financial stability consequences of the reliance of banks on US dollar markets and discuss how the supply of US dollars by non-banking entities, particularly those located in emerging economies, can create risks to the global financial system.