Cross‐Border Residential Lending: Theory and Evidence from the European Sovereign Debt Crisis

We examine bank strategies to rebalance residential mortgage portfolios toward other geographical regions in the context of the European sovereign debt crisis. For banks in Greece, Ireland, Cyprus, Italy, Portugal and Spain (GICIPS), we find evidence of flight‐to‐quality if banks were undercapitalized and had high funding cost, and evidence of risky‐lending if banks were undercapitalized but without funding problems. For banks in core safe European countries, we find evidence of flight‐to‐quality among banks with high capital ratios, and risky‐lending among banks with low funding cost. We rationalize these empirical results with a general equilibrium model of cross‐border mortgage lending.