Bank and Sovereign Debt Risk Connection

Abstract

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Sovereign risk, bank funding and investors’ pessimism

“…Banks face liquidity risk since investors of short term liabilities can coordinate and run in face of bad news on banks' assets. Banks can insure against liquidity short-falls in a repo market, but this requires collateral in 16 Also documented Darraq-Paries, Faia and Palenzuela [17]. 17 Notice that for Greece there are some missing data.…”

“…Banks can insure against liquidity short-falls in a repo market, but this requires collateral in 16 Also documented Darraq-Paries, Faia and Palenzuela [17]. 17 Notice that for Greece there are some missing data. This might explain the relatively low correlation compared to other countries.…”

“…6 See Orphanides [29] for the effects of stress tests announcements. 7 Darraq-Paries, Faia and Palenzuela [17] assess the ECB full allotment policy using a similar model. 8 See Blanchard, L'Huillier and Lorenzoni [10].…”

Credibility and Crisis Stress Testing

“…Sovereign CDS spreads provide an indication of the perceived creditworthiness of a country, which is considered closely linked to the health of its banking sector given the potential implications for the public purse if government support is required (Mody and Sandri [16]). In several banking systems, the high holdings of sovereign debt have focused market concerns on the bank-sovereign feedback loop (Acharya et al [17]; Committee on the Global Financial System [18]; Angeloni and Wolff [19]; Darraq Paries et al [20]).…”

Credibility and Crisis Stress Testing

“…Sovereign CDS spreads provide an indication of the perceived creditworthiness of a country, which is considered closely linked to the health of its banking sector given the potential implications for the public purse if government support is required (Mody and Sandri [16]). In several banking systems, the high holdings of sovereign debt have focused market concerns on the bank-sovereign feedback loop (Acharya et al [17]; Committee on the Global Financial System [18]; Angeloni and Wolff [19]; Darraq Paries et al [20]). …”