Flight to Where? Evidence from Bank Investments During the Financial Crisis

This paper analyzes how banks react to the financial crisis and a deteriorating solvency and liquidity condition in their investment decisions and the composition of their financial assets. We use a novel dataset, which comprises all security investments by all German banks on a security-by-security basis between 2006 and 2011, and analyze whether and how banks use sales and purchases of these securities as the most direct and immediate way to change their overall asset structure. We find that banks substantially change their investment strategies with the beginning of the financial crisis. In particular, they shift their investments towards securities that are eligible as collateral in central bank credit operations and towards domestic securities. These patterns hold in particular for less healthy, lowly rated and large banks. Furthermore, banks with substantial exposure to troubled assets as for example Greek government bonds are particularly active in this perspective. Our results highlight the substantial changes in bank portfolios following the financial crisis, which constitute a major part of their assets, and have important implications for the current regulatory as well as policy debate on banks’ investment decisions.