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Transmission of Sovereign Risk to Bank Lending

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Abstract

Banks hold a significant exposure to their own sovereigns. An increase in sovereign risk may hurt banks' balance sheets, causing a decrease in lending and a decline in economic activity. We quantify the transmission of sovereign risk to bank lending and provide new evidence about the effect of sovereign risk on economic outcomes. We consider the 1999 Marmara earthquake in Turkey as an exogenous shock leading to an increase in Turkey's default risk. Our empirical estimates show that, for banks holding a higher amount of government securities, the exogenous change in sovereign default risk tightens banks' financial constraints significantly. The banks' resulting tighter financial constraints translate into lower credit provision, suggesting that there is a significant balance-sheet channel in transmitting a higher sovereign default risk toward real economic activity.

Suggested Citation

  • Yusuf Soner Başkaya & Bryan Hardy & Ṣebnem Kalemli-Özcan & Vivian Z. Yue, 2023. "Transmission of Sovereign Risk to Bank Lending," Policy Hub, Federal Reserve Bank of Atlanta, vol. 2023(2), February.
    • Handle: RePEc:fip:a00068:96728
    DOI: 10.29338/ph2023-2
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    More about this item

    Keywords

    banking crisis; bank balance sheets; lending channel; public debt; credit supply;
    All these keywords.

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • F15 - International Economics - - Trade - - - Economic Integration
    • F36 - International Economics - - International Finance - - - Financial Aspects of Economic Integration
    • O16 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Financial Markets; Saving and Capital Investment; Corporate Finance and Governance

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