The evolving nexus: sovereigns, banks and NBFIs

This paper documents that the traditional sovereign-bank nexus has morphed into a broader nexus that now also includes non-bank financial institutions (NBFIs): the sovereign-bank-NBFI nexus. The classical sovereign-bank nexus has been a major financial stability concern following the eurozone crisis. Since then, sovereign debt levels have increased substantially in many major economies, while NBFIs' footprint in sovereign bond markets has grown significantly. This paper examines the transmis sion of risks among banks, sovereigns and NBFIs using European bank-level data and global country-level data. We find that banks' direct sovereign exposures have recently become less important in explaining the co-movement between bank and sovereign risk. By contrast, banks' exposures to NBFIs have become a significant determinant of the bank-sovereign risk co-movement. We also find evidence that NBFIs' sovereign debt holdings have become important drivers of the co-movement between NBFI and sovereign risk.