Bank Regulation and Sovereign Risk: A Paradox

Antonio Afonso and André Teixeira

No 2023/0272, Working Papers REM from ISEG - Lisbon School of Economics and Management, REM, Universidade de Lisboa

Abstract: This paper investigates the impact of banking prudential regulation on sovereign risk. We show that prudential regulation reduces sovereign risk and induces governments to spend more. As a result, countries with tight prudential regulation have lower primary budget balances and accumulate more government debt over time. This means that prudential regulation reduces private debt, while paradoxically increasing government debt. We explore several explanations for this paradox. Our results suggest that prudential regulation enables governments to accumulate debt because they improve the nation’s credit rating and its borrowing conditions in sovereign bond markets.

Keywords: bank regulation; fiscal policy; macroprudential policy; sovereign debt; sovereign risk. (search for similar items in EconPapers)
JEL-codes: E52 E58 E62 G28 H3 (search for similar items in EconPapers)
Date: 2023-05
New Economics Papers: this item is included in nep-ban, nep-cba and nep-fdg
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Related works:
Working Paper: Bank Regulation and Sovereign Risk: A Paradox (2023)
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Persistent link: https://EconPapers.repec.org/RePEc:ise:remwps:wp02722023

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