Ari,Anil, (2016), ” Sovereign risk and bank risk-taking”, ECB Working Paper Series No 1894, April 2016
In 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 Önancial 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-fulÖlling 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.
Relevant Posts
- Fratzscher, Marcel, Rieth, Malte, (2015), “Monetary Policy, Bank Bailouts and the Sovereign-bank Risk Nexus in the Euro Area”, European Commission Directorate-General for Economic and Financial Affairs, DISCUSSION PAPER 009, September 2015
- Pienkowski, Alex , Saito, Joyce Miharu,Tambunlertchai, Suchanan, (2016), “Public debt in low-income countries: Risks and opportunities”, Voxeu, 28 March
- Gerba, Eddie, Macchiarelli, Corrado, (2016), “Policy options and risks of an extension of the ECB’s quantitative easing programme: An analysis”, European Parliament, February