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A zero-risk weight channel of sovereign risk spillovers

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  • Kirschenmann, Karolin
  • Korte, Josef
  • Steffen, Sascha

Abstract

European banks are exposed to a substantial amount of risky sovereign debt. “Missing capital” in the banking system resulting from the zero-risk weight exemption for European sovereign debt amplifies the co-movement between sovereign CDS spreads and facilitates cross-border crisis spillovers. Risks spill over from risky peripheral sovereigns to safer core countries, but not in the opposite direction nor for exposures to countries not exempted from risk-weighting. Unfunded non-domestic sovereign bond exposures primarily affect CDS spreads of non-GIIPS banks, while domestic sovereign-to-bank linkages are particularly important for GIIPS banks. Spillovers are attenuated when banks fund their sovereign bond exposures with capital.

Suggested Citation

  • Kirschenmann, Karolin & Korte, Josef & Steffen, Sascha, 2020. "A zero-risk weight channel of sovereign risk spillovers," Journal of Financial Stability, Elsevier, vol. 51(C).
  • Handle: RePEc:eee:finsta:v:51:y:2020:i:c:s1572308920300796
    DOI: 10.1016/j.jfs.2020.100780
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    More about this item

    Keywords

    Sovereign debt; Sovereign risk; Bank risk; CDS; Contagion; Zero risk weight; Basel III; CRD; EBA capital exercise;
    All these keywords.

    JEL classification:

    • G01 - Financial Economics - - General - - - Financial Crises
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
    • F23 - International Economics - - International Factor Movements and International Business - - - Multinational Firms; International Business

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