BRRD credibility and the bank-sovereign nexus

Lamers, Martien; Present, Thomas; Vennet, Rudi Vander; Soenen, Nicolas

doi:10.1080/13504851.2022.2052007

Cited by 6 publications

(2 citation statements)

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“…They report that the sensitivity of bank CDS spreads for changes in sovereign CDS spreads diminishes in subperiods after the introduction of the BRRD, suggesting that the new bail-in regime decreased the interconnections between sovereigns and banks. Similarly, studies investigating the correlation between sovereign and bank CDS spreads typically conclude that it has diminished in the BRRD era, although it has not become insignificant [ 11 ]. However, the mitigation of the bank-sovereign nexus may be caused by lower bank risk, but also by lower sovereign risk.…”

Section: Related Literaturementioning

confidence: 99%

“…However, [ 10 ] conclude that the markets do not judge the BRRD as credible, since instead of the expected widening of the gap between bank and sovereign CDS spreads in the BRRD period, the gap narrows. Some studies also report that although the sovereign/bank correlation decreased, it did not disappear [ 11 ]. The correlation between sovereign and bank bond yields or CDS spreads may be caused by the two-way interaction between sovereign risk and bank risk, as shown by [ 12 ].…”

Section: Introductionmentioning

confidence: 99%

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Does BRRD mitigate the bank-to-sovereign risk channel?

Lamers,

Present,

Soenen

et al. 2024

PLoS ONE

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We investigate the effectiveness of the Bank Recovery and Resolution Directive (BRRD) in mitigating the transmission of credit risk from banks to their sovereign, using CDS spreads to capture bank and sovereign credit risk for a sample of 43 banks in 8 Euro Area countries over the period 2009–2020. If the BRRD bail-in framework is credible, changes in bank default risk should not be transmitted to sovereign risk. In a novel approach we use banks earnings announcements to identify exogenous shocks to bank credit risk and investigate to what extent bank risk is transmitted to sovereign risk before and during the BRRD era. We find that bank-to-sovereign risk transmission has diminished after the introduction of the BRRD, suggesting that financial markets judge the BRRD framework as credible. The decline in bank-sovereign risk transmission is particularly significant in the periphery Euro Area countries, especially Italy and Spain, where the bank-sovereign nexus was most pronounced during the sovereign debt crisis. We report that the lower bank-to-sovereign credit risk transmission is associated with the parliamentary approval of the BRRD and not with the OMT program launched by the ECB to affect sovereign yield spreads, nor with specific bail-in or bailout cases which occurred during the BRRD era. Finally, we document that the reduction in risk transmission is most pronounced for banks classified as a Global Systemically Important Bank (G-SIB), stressing the importance of additional capital buffers imposed by Basel III.

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Section: Related Literaturementioning

confidence: 99%