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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 banks’ 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 banks’ heavy exposure to sovereigns. This issue should be given more attention in European policy discussions on how to strengthen the euro area.

Suggested Citation

  • Silvia Merler & Jean Pisani-Ferry, 2012. "Who's afraid of sovereign bonds?," Policy Contributions 695, Bruegel.
  • Handle: RePEc:bre:polcon:695
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    Cited by:

    1. Blattner, Tobias & Joyce, Michael A. S., 2016. "Net debt supply shocks in the euro area and the implications for QE," Working Paper Series 1957, European Central Bank.
    2. Jean Pisani-Ferry, 2012. "The Euro crisis and the new impossible trinity," Policy Contributions 674, Bruegel.
    3. Equiza-Goñi, Juan, 2016. "Government debt maturity and debt dynamics in euro area countries," Journal of Macroeconomics, Elsevier, vol. 49(C), pages 292-311.
    4. Bremus, Franziska M., 2015. "Cross-border banking, bank market structures and market power: Theory and cross-country evidence," Journal of Banking & Finance, Elsevier, vol. 50(C), pages 242-259.
    5. Chiara Angeloni & Guntram B. Wolff, 2012. "Are banks affected by their holdings of government debt?," Working Papers 717, Bruegel.
    6. Broner, Fernando & Erce, Aitor & Martin, Alberto & Ventura, Jaume, 2014. "Sovereign debt markets in turbulent times: Creditor discrimination and crowding-out effects," Journal of Monetary Economics, Elsevier, vol. 61(C), pages 114-142.
    7. Cornand, Camille & Gandré, Pauline & Gimet, Céline, 2016. "Increase in home bias in the Eurozone debt crisis: The role of domestic shocks," Economic Modelling, Elsevier, vol. 53(C), pages 445-469.
    8. Gianluca Cafiso, 2013. "Public-Debt Financing in the case of External Debt," Working Papers 2013-37, CEPII research center.
    9. Peter Claeys & Borek Vašícek, 2012. "“Measuring Sovereign Bond Spillover in Europe and the Impact of Rating News”," IREA Working Papers 201219, University of Barcelona, Research Institute of Applied Economics, revised Nov 2012.
    10. Merler, S. & Pisani-Ferry, J., 2012. "Hazardous tango: sovereign-bank interdependence and financial stability in the euro area," Financial Stability Review, Banque de France, issue 16, pages 201-210, April.
    11. Serkan Arslanalp & Takahiro Tsuda, 2012. "Tracking Global Demand for Advanced Economy Sovereign Debt," IMF Working Papers 12/284, International Monetary Fund.
    12. Zsolt Darvas, 2012. "The euro crisis: ten roots, but fewer solutions," Policy Contributions 755, Bruegel.
    13. Kollintzas, Tryphon & Tsoukalas, Konstantinos, 2015. "Bank and Sovereign Risk Interdependence in the Euro Area," CEPR Discussion Papers 10485, C.E.P.R. Discussion Papers.
    14. Juan Equiza Goni, 2014. "Sovereign Debt Maturity and Debt-to GDP Dynamics in Six Euro Area Countries," Working Papers ECARES ECARES 2014-44, ULB -- Universite Libre de Bruxelles.
    15. 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.
    16. Silvia Merler & Jean Pisani-Ferry, 2012. "Sudden Stops in the Euro Area," Review of Economics and Institutions, Università di Perugia, vol. 3(3).
    17. Margherita Bottero & Simone Lenzu & Filippo Mezzanotti, 2014. "Sovereign Debt Exposure and the Bank Lending Channel: Impact on Credit Supply and the Real Economy," Working Paper 220976, Harvard University OpenScholar.
    18. Marta Gómez-Puig & Simón Sosvilla-Rivero & Manish K. Singh, 2018. "“Incorporating creditors' seniority into contingent claim models:Application to peripheral euro area countries”," IREA Working Papers 201803, University of Barcelona, Research Institute of Applied Economics, revised Feb 2018.

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