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Who's afraid of sovereign bonds?

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  • Silvia Merler
  • Jean Pisani-Ferry

Abstract

The crisis has underlined the strong interdependence between the euro-area banking and sovereign crises. To understand the role domestic banks have played in holding sovereign debt, a breakdown of government debt by holding sectors is required. The data shows that at the start of the crisis, most continental euro-area countries were characterised by the large size of their banksâ?? portfolios of domestic government bonds, which were markedly larger than in the UK or the US. Consequently, concern about sovereign solvency was bound to have major consequences for banks. The structural vulnerability of euro-area countries has increased, reinforcing the sovereign/ banking crisis vicious cycle. All countries for which concerns about state solvency arose in recent years have seen a reversal in the previously steady increase of the share of government debt held by non residents. Germany, by contrast, has seen an increase in the share held by non residents. In the short term, these observations raise a question about the effectiveness of ECB provision of liquidity to banks as a means to alleviate the sovereign crisis. At a point when government bonds are considered risky assets, euro-area banks are faced with both balance sheet and reputational risks compared to their non-euro area counterparts, and may prove reluctant to increase this exposure further. In the longer term, the question is if and how euro-area regulators should set incentives to reduce banksâ?? heavy exposure to sovereigns. This issue should be given more attention in European policy discussions on how to strengthen the euro area.

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Bibliographic Info

Paper provided by Bruegel in its series Policy Contributions with number 695.

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Date of creation: Feb 2012
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Handle: RePEc:bre:polcon:695

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Cited by:
  1. Fernando Broner & Aitor Erce & Alberto Martin & Jaume Ventura, 2013. "Sovereign Debt Markets in Turbulent Times: Creditor Discrimination and Crowding-Out Effects," NBER Working Papers 19676, National Bureau of Economic Research, Inc.
  2. Serkan Arslanalp & Takahiro Tsuda, 2012. "Tracking Global Demand for Advanced Economy Sovereign Debt," IMF Working Papers 12/284, International Monetary Fund.
  3. Fernando Broner & Aitor Erce & Alberto Martin & Jaume Ventura, 2013. "Sovereign Debt Markets in Turbulent Times: Creditor Discrimination and Crowding-Out," IMF Working Papers 13/270, International Monetary Fund.
  4. Silvia Merler & Jean Pisani-Ferry, 2012. "Sudden Stops in the Euro Area," Review of Economics and Institutions, Università di Perugia, vol. 3(3).
  5. Jean Pisani-Ferry, 2012. "The Euro crisis and the new impossible trinity," Policy Contributions 674, Bruegel.
  6. repec:aqr:wpaper:201209 is not listed on IDEAS
  7. Peter Claeys & Borek Vasicek, 2012. "Measuring Sovereign Bond Spillover in Europe and the Impact of Rating News," Working Papers 2012/07, Czech National Bank, Research Department.
  8. Chiara Angeloni & Guntram B. Wolff, 2012. "Are banks affected by their holdings of government debt?," Working Papers 717, Bruegel.
  9. Zsolt Darvas, 2012. "The euro crisis: ten roots, but fewer solutions," Policy Contributions 755, Bruegel.
  10. Gianluca Cafiso, 2013. "Public-Debt Financing in the case of External Debt," Working Papers 2013-37, CEPII research center.

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