Arbeitspapier
The Bank-Sovereign Loop and Financial Stability in the Euro Area
We propose a simple model that captures the link between bank and sovereign credit risk. It allows evaluating policy options to address this ‘doom loop’ in which the government may need to raise debt to recapitalise banks, and an increase in government debt raises sovereign risk and in turn generates potential bank losses via their (sovereign) bond holdings. Hence, an initial shock originating either in the banking or sovereign sector is amplified by the feedback relation. We set up a framework based on detailed actual bank balance sheets and test the model on 35 large EU banking groups, across 7 European countries. The effects of the feedback loops in most cases more than double the effect of the initial shock on bank losses and the sovereign risk premium. We show that a single EU bank resolution mechanism, European Stability Mechanism (ESM) direct bank recapitalisations, and bondholder “bail-in” can be effective to dampen the bank-sovereign loop. Addressing the home bias in banks sovereign bond holdings by reducing excessive exposure to domestic sovereigns has only limited benefit in terms of lower crisis doom loop effects as contagion effects increase.
- ISBN
-
978-92-76-02955-7
- Sprache
-
Englisch
- Erschienen in
-
Series: JRC Working Papers in Economics and Finance ; No. 2019/10
- Klassifikation
-
Wirtschaft
Financial Markets and the Macroeconomy
Financial Crises
Banks; Depository Institutions; Micro Finance Institutions; Mortgages
National Debt; Debt Management; Sovereign Debt
Governmental Loans; Loan Guarantees; Credits; Grants; Bailouts
- Thema
-
Credit Risk
Banks
Sovereign
Financial Stability
ESM
Direct Recapitalisation
- Ereignis
-
Geistige Schöpfung
- (wer)
-
Langedijk, Sven
Fontana, Alessandro
- Ereignis
-
Veröffentlichung
- (wer)
-
Publications Office of the European Union
- (wo)
-
Luxembourg
- (wann)
-
2019
- DOI
-
doi:10.2760/81563
- Handle
- Letzte Aktualisierung
-
10.03.2025, 11:43 MEZ
Datenpartner
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Objekttyp
- Arbeitspapier
Beteiligte
- Langedijk, Sven
- Fontana, Alessandro
- Publications Office of the European Union
Entstanden
- 2019
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