Italian Sovereign Spreads: Their Determinants and Pass-through to Bank Funding Costs and Lending Conditions

Abstract

Volatility in Italian sovereign spreads has increased since mid-2011. This paper finds that news on the euro area debt crisis and country specific events were important drivers of sovereign spreads. Movements in sovereign spreads affect CDS spreads and bond yields of Italian banks, and are transmitted rapidly to firm lending rates. Banks with lower capital ratios and higher nonperforming loans were found to be more sensitive to swings in sovereign spreads. Credit supply constraints due to bank funding shortages from the sovereign debt crisis were a major factor behind the lending slowdown in late 2011, while in 2012 weak demand appears to have been driving changes in credit more than supply.

Modern Financial Crises

“…Larger-risk premia associated with securities issued by banks and interbank borrowing have raised the cost of market funding for banks (ECB 2009(ECB , 2010aZoli 2013). Financial market conditions have become heterogeneous reversing a trend of lower and more similar rates since the late 1990s.…”

Yields on Sovereign Debt, Fragmentation and Monetary Policy Transmission in the Euro Area: A GVAR Approach

“…One aspect that can accelerate the process is the fact that the rise in the interest rate on sovereign debt, in turn, can reduce the traction of monetary policy, as shown by Al-Eyd and Berkmen (2013) and Zoli (2013).…”

“…In our model, therefore, we include 10-year sovereign bond yields and corporate leverage in each of the euro area countries. The former is a indication of the degree of financial frictions in the euro area (see Mayordomo et al, 2015or Zoli, 2013, while the latter provides a channel of the transmission of monetary policy (see Bech and Malkhoroz, 2016) and one that is particularly sensible to financial tensions and potential lack of credibility of the euro area. Finally, we include a measure of euro area turmoil in financial markets: a composite indicator of systemic stress (CISS) calculated and published by the ECB (see, Holló et al, 2012).…”

The Mechanics of a Strong Euro Area

“…The paper finds that the problems in the bank lending channel (caused by funding constraints) have been mitigated by the ECB's unconventional monetary policy instruments, but that the transmission mechanism through the firm balance sheet channel remains impaired (as of end -2011) and appears more prevalent in small banks (which tend to lend primarily to SMEs). Zoli (2013) focuses on the Italian financial system and finds that sovereign spreads have transmitted to bank CDS spreads and bond yields, which were transmitted to firm lending rates. In addition, banks with lower capital ratios and higher NPLs were found to be more sensitive to sovereign spreads.…”