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The Vulnerability of Banks to Government Default Risk in the EMU

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Author Info
Arnold, Ivo
Lemmen, Jan

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Abstract

This paper examines the vulnerability of banks in EMU countries to shocks to default risk premiums on public debt. This vulnerability depends on the total amount of public debt in bank portfolios, the degree of geographical diversification of public debt holdings by banks, and the extent to which the default risk of EMU governments is diversifiable. We calculate the effect of country-specific default shocks on the public debt portfolios of banks. The calculations are based on data of public debt positions at the aggregate banking sector level and take into account the historical covariance structure of default risk premiums in the EMU. We compare the following scenarios. First, we calculate the effect on the standard deviation of the capital-to-assets ratio if banks continue to hold mainly domestic public debt. Next, we calculate this effect if banks diversify their investments in public debt. We find that the standard deviation of the capital-to-assets ratio can decline considerably if banks diversify their public debt holdings. We close with some implications for prudential regulation. Copyright 2001 by Blackwell Publishers Ltd.

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Article provided by Blackwell Publishing in its journal International Finance.

Volume (Year): 4 (2001)
Issue (Month): 1 (Spring)
Pages: 101-25
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Handle: RePEc:bla:intfin:v:4:y:2001:i:1:p:101-25

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  1. Roel Beetsma & Koen Vermeylen, 2007. "The effect of monetary unification on public debt and its real return," Public Choice, Springer, vol. 133(3), pages 393-415, December. [Downloadable!] (restricted)
    Other versions:
  2. Kerstin Bernoth & Jürgen von Hagen & Ludger Schuknecht, 2004. "Sovereign risk premia in the European government bond market," Working Paper Series 369, European Central Bank. [Downloadable!]
  3. Samir Jahjah, 2001. "Financial Stability and Fiscal Crises in a Monetary Union," IMF Working Papers 01/201, International Monetary Fund. [Downloadable!]
  4. Ullrich, Katrin, 2006. "Market discipline and the use of government bonds as collateral in the EMU," ZEW Discussion Papers 06-46, ZEW - Zentrum für Europäische Wirtschaftsforschung / Center for European Economic Research. [Downloadable!]
  5. Kerstin Bernoth & Jürgen von Hagen & Ludger Schuknecht, 2006. "Sovereign Risk Premiums in the European Government Bond Market," Discussion Papers 151, SFB/TR 15 Governance and the Efficiency of Economic Systems, Free University of Berlin, Humboldt University of Berlin, University of Bonn, University of Mannheim, University of Munich. [Downloadable!]
  6. Philipp Paulus, 2006. "Brüssel, Frankfurt oder Basel - Wo muss das Problem steigender Staatsschulden in der Europäischen Währungsunion gelöst werden?," Otto-Wolff-Institut Discussion Paper Series 01/2006, Otto-Wolff-Institut für Wirtschaftsordnung, Köln, Deutschland. [Downloadable!]
  7. Marta Gómez-Puig, . "Monetary integration and the cost of borrowing," Working Papers on International Economics and Finance 05-05, FEDEA. [Downloadable!]
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  8. Debora Di Gioacchino & Sergio Ginebri & Laura Sabani, 2005. "Public Debt Repudiation In A Monetary Union: The Role Of The Geographical Allocation Of Domestic Debt," Working Papers 81, Sapienza University of Rome, Department of Public Economics. [Downloadable!]
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