Impacts Of The Sovereign Default Crisis On The Czech Financial Sector

This article discusses the experience of countries hit by debt crises as well as the channels of contagion of sovereign default risk to the financial system. It focuses primarily on identifying channels of contagion that might represent a relevant threat to the Czech economy and discusses their significance. Although sovereign default risk is currently relatively low for the Czech Republic thanks to its low level of government debt, an escalation of this risk would have significant impacts on the financial system given the comparatively high proportion of government bonds in banks' balance sheets. The article also illustrates the significance of cross-country contagion to sovereign credit premiums. Here, the transmission from the countries hit hardest by the debt crisis has weakened, but the Czech Republic's credit premium is diverging from the most stable countries at a time of market stress. The risk of heightened sensitivity of credit premiums to a country's debt may increase the costs of irresponsible fiscal policy in the future. It is therefore another factor that should be covered by financial stability analysis.