Sovereign Default, Domestic Banks, and Financial Institutions

Gennaioli, Nicola; Martín, Alberto; Rossi, Stefano

doi:10.2139/ssrn.2023428

“…Research into credit default swaps is dominated by the examination of i) the determinants of sovereign credit risk and defaults (Breitenfellner and Wagner 2012, Aizenman et al 2013, Ang and Longstaff 2013and Beirne and Fratzscher 2013, ii) the adverse effects to the banking sector during sovereign defaults (Panageas 2010, Acharya andRajan 2013), and iii) the cost of bank bailouts to the government (Gorton and Huang 2004;Diamond and Rajan 2005). Only recently, studies on two-way feedback effects between the risk of default in the banking and public sectors have emerged (Reinhart and Rogoff 2011, Alter and Schüler 2012, Acharya et al 2013and Gennaioli et al 2014. Key in this research 1 The threat of total collapse of large financial institutions provoked large-scale rescue packages, announced by euro area governments in September 2008 in an attempt to increase the resilience of the banking sector.…”

mentioning

confidence: 99%

The quest for banking stability in the euro area: The role of government interventions

Kizys

¹

,

Paltalidis

²

,

Vergos

³

2016

Journal of International Financial Markets, Institutions and Mo

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Use policyThe full-text may be used and/or reproduced, and given to third parties in any format or medium, without prior permission or charge, for personal research or study, educational, or not-for-prot purposes provided that:• a full bibliographic reference is made to the original source • a link is made to the metadata record in DRO • the full-text is not changed in any way The full-text must not be sold in any format or medium without the formal permission of the copyright holders.Please consult the full DRO policy for further details. AbstractWe build upon a Markov-Switching Bayesian Vector Autoregression (MSBVAR) model to study how the credit default swaps market in the euro area becomes an important chain in the propagation of shocks through the entire financial system. The study sheds light on the regime-dependent interconnectedness between the risk of investing in banking and public sector bonds and provides novel evidence that a rise in sovereign debt, due to the countercyclical fiscal policy measures, is perceived by stock market investors as a burden on growth prospects. We also document that government interventions in the banking sector deteriorate the credit risk of sovereign debt. Higher risk premium required by investors for holding riskier government bonds depresses the sovereign debt market, it impairs banks" balance sheets, and it depresses the collateral value of loans leading to bank retrenchment. The ensuing two-way banking-fiscal feedback loop indicates that government interventions do not necessarily stabilize the banking sector.JEL Classification: C11, C58, G01, G21, G28.

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“…Acharya et al (2004) develop a model with interdependency between stress in the bank-ing sector and sovereign risk. Gennaioli et al (2014) in turn examine the effects of government defaults on the banking sector and private credit. And Brutti and Sauré (2015) show that cross-country bank exposures to sovereign debt of Euro area countries propagate sovereign risk.…”

Section: Theoretical Channels Of Stress Pass-troughmentioning

confidence: 99%

Sovereign Stress, Banking Stress, and the Monetary Transmission Mechanism in the Euro Area

Holtemöller

¹

,

Scherer

²

2018

SSRN Journal

0

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Standard-Nutzungsbedingungen:Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden.Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen.Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. In this paper, we investigate to what extent sovereign stress and banking stress have contributed to the increase in the level and in the heterogeneity of nonfinancial firms' financing costs in the Euro area during the European debt crisis and how both have affected the monetary transmission mechanism. Employing a large firm-level data set containing two million observations, we are able to identify the effect of government bond yield spreads (sovereign stress) and the share of non-performing loans (banking stress) on firms' financing costs in a panel model by assuming that idiosyncratic shocks to individual firms are uncorrelated with country-specific variables. We find that the two sources of stress have increased firms' financing costs controlling for country and firm-specific factors. Moreover, we estimate both to have significantly impaired the monetary transmission mechanism. Terms of use: Documents in Keywords

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“…Gennaioli, Martin and Rossi (2014) propose that banks hold sovereign bonds as a way to store liquidity. Sovereign default then reduces the liquidity available to the banking sector and leads to a decline in investment.…”

Section: Ecb Working Paper 1894 April 2016mentioning

confidence: 99%

Sovereign Risk and Bank Risk-Taking

Ratnovski

¹

2017

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Standard-Nutzungsbedingungen:Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden.Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen.Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. Terms of use: Documents in AbstractIn European countries recently hit by a sovereign debt crisis, the share of domestic sovereign debt held by the national banking system has sharply increased, raising issues in their economic and …nancial resilience, as well as in policy design. This paper examines these issues by analyzing the banking equilibrium in a model with optimizing banks and depositors. To the extent that sovereign default causes bank losses also independently of their holding of domestic government bonds, under-capitalized banks have an incentive to gamble on these bonds. The optimal reaction by depositors to insolvency risk imposes discipline, but also leaves the economy susceptible to self-ful…lling shifts in sentiments, where sovereign default also causes a banking crisis. Policy interventions face a trade-o¤ between alleviating funding constraints and strengthening incentives to gamble. Liquidity provision to banks may eliminate the good equilibrium when not targeted. Targeted interventions have the capacity to eliminate adverse equilibria. Non-Technical SummarySince the eruption of the European debt crisis, the share of domestic sovereign debt held by the national banking system has increased sharply in crisis-hit countries. This created a dangerous nexus between the …nancial health of banks and sovereigns, and was associated with a rise in bank funding costs and the crowding out of bank lending to the private sector. The high exposure of banks in crisis-hit countries to domestic sovereign debt is indeed considered a key, if not the key, source of instability in the recent European sovereign debt crisis (see e.g. Acharya et al., 2014;Farhi & Tirole, 2015;Brunnermeier et al., 2016). The question is then why have banks in the crisis-hit countries become so highly exposed to domestic sovereign debt. In this paper, I address this question from a novel angle, calling attention to the interactions between banks and depositors, each optimizing their portfolio strategies vis-à-vis the prospect of a sovereign debt crisis. I develop my analysis specifying a small open economy model with three private agents, households, banks, and non-…nancial …rms, and a government issuing default-risky debt. For the sake of clarity and analytical tractability, I focus on a two period economy. In the …rst period, banks collect deposits from households and allocate their funds between domestic sovereign bond purchases and lending to …rms in need of working capital...

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Sovereign Default, Domestic Banks, and Financial Institutions

Cited by 103 publications

References 55 publications

The quest for banking stability in the euro area: The role of government interventions

The quest for banking stability in the euro area: The role of government interventions

Sovereign Stress, Banking Stress, and the Monetary Transmission Mechanism in the Euro Area

Sovereign Risk and Bank Risk-Taking

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