Banks’ Home Bias in Government Bonds Holdings. Will Banks in Low-Rated Countries Invest in European Safe Bonds (ESBies)?

This paper offers two new explanations for banks' home bias in government bond holdings: a sovereign‐based rating cap on corporates and the existence of a ‘bank tax.’ These are complementary to the four explanations offered in the literature: risk‐shifting, gambling for resurrection, moral suasion, and a means to store liquidity for financing future investment. Collectively, they cast doubt on the European Union's demand‐led approach to investment in European safe bonds (ESBies) by banks in low‐rated countries. Bank regulations such as constraints on large exposure or risk‐based capital on credit risk concentration will be needed if the objective is to break the so‐called ‘deadly embrace.’