International portfolio frictions

BIS Working Papers  |  No 1137  | 
26 October 2023



Regulated financial institutions like banks and insurers have high demand for government bonds, for a variety of reasons. Yet the total supply of government debt in Europe, especially from countries with lower interest rates, is much smaller than the size of this segment of the financial sector. European insurance companies and pension funds (ICPF) and banks cannot all hold safe government bonds without pushing down the yields significantly, so they have to tilt their portfolios towards other securities, notably corporate bonds. This paper sheds new light on the global asset allocation of European banks and insurers.


We use a new firm-level data set focusing on 31 European Economic Area (EEA) countries over 2016–21. These data give us insights into the portfolio decisions of European banks and ICPF. We also develop a model of fixed income portfolio decisions by regulated entities to explain that, in countries with a larger ICPF sector, the corporate bond share is higher in fixed income markets, and banks and insurers allocate a larger fraction of their fixed income portfolios to corporate bonds. 


We document five novel findings that cannot be easily explained by traditional international finance portfolio frictions. First, there is significant cross-country variation in insurers' and banks' portfolio allocations, even though banks and insurers across countries all have access to global capital markets and are all subject to pan-European regulations. Second, the composition of domestic fixed income markets, as measured by the share of corporate bonds in outstanding domestic fixed income instruments, is strongly positively correlated with the fraction of the overall portfolio invested in corporate bonds for both insurers and banks. Third, insurers and banks in high-interest rate and high-credit risk countries hold overall riskier portfolios. Fourth, the foreign portfolio composition of banks and ICPF resembles their domestic financial market characteristics. Fifth, multinational groups' local subsidiaries have similar portfolio allocations to other local insurers in the same market. These portfolio biases highlight the important barriers to European capital market integration, with consequences for monetary policy transmission across countries. And as there are important cross-sectoral spillovers, a multi-sectoral approach to regulatory design may be beneficial.


We study patterns and implications of global asset allocations of European insurers and banks using newly available supervisory data. We show that the total assets of insurance companies and pension funds (ICPF) far exceed the amount of government bonds outstanding in Europe, and that countries with a large ICPF sector tend to have a large corporate bond market. Despite high levels of international investments, the characteristics of domestic financial markets still loom large in insurers' and banks' portfolio allocation, with two newly documented international portfolio frictions playing a prominent role. First, when investing abroad, insurers and banks do not offset attributes of the domestic markets (such as the composition of fixed-income markets, interest rates, and sovereign credit risk), which we label "domestic projection bias." Second, subsidiaries of multinational groups act like local entities, which we label the "going native bias." We propose a theoretical framework to explain our empirical findings and discuss the broader policy implications for European capital market deepening and integration, monetary policy transmission and financial stability, and a multi-sectoral approach to regulatory design.

JEL classification: G2, G11, G15, G21, G22, G28

Keywords : Banks, insurance companies, pension funds, portfolio choice, fixed income, home bias

Related information