Investor Information and Bank Instability During the Euro Crisis

IMF Working Papers, January 8, 2021

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Outside of financial crises, investors have little incentive to produce private information on banks’ short-term liabilities held as information-insensitive safe assets; this changes during crises.
Daily information production is measured using data from credit default swap spreads during the global financial crisis and the subsequent European debt crisis.
The study examines abnormal information production around major events and interventions during these crises.
An addendum shows information production on nonfinancials dramatically increased relative to financials at the height of the COVID-19 crisis, reflecting the nonfinancial nature of the initial shock.

Capital injections, on average, reduced abnormal information production.
Early European stress tests increased abnormal information production.
High levels of information production predict:
- Bank balance sheet contraction.
- Higher government expenditures to support financial institutions.

Daily information production proxied using credit default swap spreads.
Crises analyzed:
- The global financial crisis.
- The subsequent European debt crisis.
- Addendum: COVID-19 crisis dynamics comparing nonfinancials and financials.

Interventions that provide direct capital support (capital injections) can reduce investor incentives to produce destabilizing private information in crisis periods.
Transparency exercises or early stress tests may increase investor information production and could amplify market scrutiny during fragile periods.
Elevated investor information production signals the potential for adverse real outcomes (balance sheet contraction) and higher fiscal costs (government support to financial institutions).