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Sovereign and Bank Credit Risk during the Global Financial Crisis

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  • Irina Stanga

Abstract

This paper investigates the interaction of market views on the sustainability of sovereign debt and the perceived credit risk of banks. This interaction came into spotlight during the recent financial crisis, as government interventions in support of the financial sector were associated with increases in fiscal burden. I analyze and quantify the effect of government interventions in the domestic financial system on the default risks of the banking sector and sovereign borrowers. The paper focuses on the cases of Ireland and Spain, which experienced large public interventions in the domestic banking system and at a later stage highly volatile bond markets. For each country, I estimate a Vector Autoregression model to trace the interaction among sovereign CDS spreads, bank CDS spreads, and a measure of the business cycle over the sample period 2007-2011. I identify shocks by imposing sign restrictions on the impulse response functions. The results point towards a risk transfer from the financial to the sovereign sector, which generates an increase in the credit risk of the latter but only a temporary drop in that of banks.

Suggested Citation

  • Irina Stanga, 2011. "Sovereign and Bank Credit Risk during the Global Financial Crisis," DNB Working Papers 314, Netherlands Central Bank, Research Department.
  • Handle: RePEc:dnb:dnbwpp:314
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    References listed on IDEAS

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    Cited by:

    1. Rieth, Malte & Fratzscher, Marcel, 2014. "Monetary policy, bank bailouts and the sovereign-bank risk nexus in the euro area," Annual Conference 2014 (Hamburg): Evidence-based Economic Policy 100277, Verein für Socialpolitik / German Economic Association.
    2. Sören Radde & Cristina Checherita-Westphal & Wei Cui, 2015. "Government Bond Liquidity and Sovereign-Bank Interlinkages," SFB 649 Discussion Papers SFB649DP2015-032, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany.
    3. Markus Brunnermeier & Laurent Clerc & Yanis El Omari & Silvia Gabrieli & Steffen Kern & Christoph Memmel & Tuomas Peltonen & Natalia Podlich & Martin Scheicher & Guillaume Vuillemey, 2013. "Assessing contagion risks from the CDS market," ESRB Occasional Paper Series 04, European Systemic Risk Board.
    4. Stefano Neri & Tiziano Ropele, 2015. "The macroeconomic effects of the sovereign debt crisis in the euro area," Temi di discussione (Economic working papers) 1007, Bank of Italy, Economic Research and International Relations Area.

    More about this item

    Keywords

    Financial Crises; Sovereign Debt; VAR; Sign Restrictions;

    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt

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