Sovereign Default Risk and Bank Balance Sheets
AbstractThis paper explores how banks' balance sheets and sovereign risk affect macroeconomic fluctuations jointly. The heightened sovereign risk and a potential default constrain the banks' ability to extend credit to firms. This happens through the capital requirement that limits the size of the bank loans to firms and government to a fraction of the banks' equity. An increase in non-performing loans to firms also hampers the bank balance sheets. With the joint interaction of sovereign risk and bank balance sheets in place, the paper, first, shows the bank balance sheet stresses and the government's need for funds to provide deposit insurance can trigger a sovereign default. The paper then examines how the introduction of specific risk weights for certain assets affect macroeconomic fluctuations and, more importantly, the joint determination of sovereign debt and banking crises.
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Bibliographic InfoPaper provided by Society for Economic Dynamics in its series 2013 Meeting Papers with number 1045.
Date of creation: 2013
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Postal: Society for Economic Dynamics Christian Zimmermann Economic Research Federal Reserve Bank of St. Louis PO Box 442 St. Louis MO 63166-0442 USA
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