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The eurozone financial crisis: role of interdependencies between bank and sovereign risk

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  • James R. Barth
  • Apanard (Penny) Prabha
  • Greg Yun
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    Abstract

    Purpose – The purpose of this paper is to discuss and then analyze the interdependency between bank and sovereign risk before, during and after the financial crisis. Design/methodology/approach – The authors' approach is based upon an examination of 44 large banks headquartered in 13 countries; eight of these countries belong to the European Union, seven belong to the eurozone, and the remaining five belong to neither group. This provides a good comparison group of countries. Findings – Evidence is found supporting the existence of significant bank and sovereign risk linkages. There are, however, different patterns in the relationships across countries and even across banks within the same country. Also, higher correlations between bank and sovereign risk are found in countries in which the ratio of the assets of banks relative to their home country's GDP is relatively high. Research limitations/implications – Based upon the empirical results, allowing banks to invest in sovereign debt without requiring them to hold any capital against the “true” risk of such debt increases the likelihood of insolvency. This means that interdependencies between bank and sovereign risk are extremely important when setting regulatory capital requirements and considering whether action is needed to limit any increase in the likelihood of contagion. Originality/value – The paper provides a new examination of the interdependencies between individual bank risk and the sovereign risk of the countries in which they are headquartered, with special emphasis on the recent global financial and eurozone crises. JEL classification: G01, G0, G, G21, G2, G28

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    Bibliographic Info

    Article provided by Emerald Group Publishing in its journal Journal of Financial Economic Policy.

    Volume (Year): 4 (2012)
    Issue (Month): 1 (April)
    Pages: 76-97

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    Handle: RePEc:eme:jfeppp:v:4:y:2012:i:1:p:76-97

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    Related research

    Keywords: Asset diversification; Bailout; Banks; Capital; Capital requirements; Credit default swap spreads; Fixed assets; Risk-weighted assets; Sovereign debt crisis;

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    References

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    1. Reinhart, Carmen & Rogoff, Kenneth, 2009. "Banking Crises: An Equal Opportunity Menace," CEPR Discussion Papers 7131, C.E.P.R. Discussion Papers.
    2. Gerlach, Stefan & Schulz, Alexander & Wolff, Guntram B., 2010. "Banking and Sovereign Risk in the Euro Area," CEPR Discussion Papers 7833, C.E.P.R. Discussion Papers.
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    Cited by:
    1. Markus K. Brunnermeier & Martin Oehmke, 2012. "Bubbles, Financial Crises, and Systemic Risk," NBER Working Papers 18398, National Bureau of Economic Research, Inc.

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