Asset encumbrance in banks: Is systemic risk affected?

The growing reliance on secured funding by banks has increased the relevance of collateralization and asset encumbrance (AE). This paper examines the main determinants of AE and verify its effects on banks’ systemic risk, which threatens financial stability. Using a novel dataset including hand-collected data on AE from banks’ Pillar III reports, we perform a panel regression analysis for European listed banks from 2014 to 2019. We find that the AE ratio is driven mainly by the bank business model, capitalization and sovereign funding conditions. Our empirical results highlight that it is not the AE level per se that influences banks’ systemic risk, but rather the change in encumbered assets. Nevertheless, bank capitalization plays a strong moderating role in this relationship. According to our results, supervisors and policy makers should pay specific attention to the combined phenomena involved in the increasing encumbrance in less capitalized banks.