The Vulnerability of Banks to Government Default Risk in the EMU
AbstractThis 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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Bibliographic InfoArticle provided by Wiley Blackwell in its journal International Finance.
Volume (Year): 4 (2001)
Issue (Month): 1 (Spring)
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Web page: http://www.blackwellpublishing.com/journal.asp?ref=1367-0271
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- Ivo J. M. Arnold & Jan J.G. Lemmen, 1999. "The Vulnerability of Banks to Government default risk in the EMU," FMG Special Papers sp115, Financial Markets Group.
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