Sovereign Risk and Bank Lending: Theory and Evidence from a Natural Disaster

Yusuf Baskaya, Bryan Hardy, Ṣebnem Kalemli-Özcan () and Vivian Yue

No 2023-01, FRB Atlanta Working Paper from Federal Reserve Bank of Atlanta

Abstract: We quantify the sovereign-bank doom loop by using the 1999 Marmara earthquake as an exogenous shock leading to an increase in Turkey’s default risk. Our theoretical model illustrates that for banks with higher exposure to government securities, a higher sovereign default risk implies lower net worth and tightening financial constraint. Our empirical estimates confirm the model’s predictions, showing that the exogenous change in sovereign default risk tightens banks’ financial constraints significantly for banks that hold a higher amount of government securities. The resulting tighter bank financial constraints translate into lower credit provision, suggesting that there is a significant balance-sheet channel in transmitting a higher sovereign default risk toward real economic activity.

Keywords: banking crisis; bank balance sheets; lending channel; public debt; credit supply (search for similar items in EconPapers)
JEL-codes: E32 F15 F36 O16 (search for similar items in EconPapers)
Pages: 58
Date: 2023-02-09
New Economics Papers: this item is included in nep-des, nep-env and nep-opm
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Citations: View citations in EconPapers (2)

Published in 2023

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Persistent link: https://EconPapers.repec.org/RePEc:fip:fedawp:95901

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DOI: 10.29338/wp2023-01

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