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Sovereign risk and bank fragility

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  • Anand, Kartik
  • Mankart, Jochen

Abstract

We develop a model of bank risk-taking with strategic sovereign default risk. Domestic banks invest in real projects and purchase government bonds. While an increase in bond purchases crowds out profitable investments, it improves the government's incentives to repay and therefore lowers its borrowing costs. For low levels of government debt, banks influence their default risks through purchases of bonds. But, for high debt levels, this influence is lost since bank and government default are perfectly correlated. Banks fail to account for how their bond purchases influence the government's default incentives. This leads to socially inefficient levels of bond holdings.

Suggested Citation

  • Anand, Kartik & Mankart, Jochen, 2020. "Sovereign risk and bank fragility," Discussion Papers 54/2020, Deutsche Bundesbank.
  • Handle: RePEc:zbw:bubdps:542020
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    References listed on IDEAS

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    More about this item

    Keywords

    sovereign debt; financial intermediation; financial repression; bank fragility;
    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

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