What drives the relationship between bank and sovereign credit risk?

Isabel Schnabel and Ulrich Schüwer

No 07/2016, Working Papers from German Council of Economic Experts / Sachverständigenrat zur Begutachtung der gesamtwirtschaftlichen Entwicklung

Abstract: The positive relationship between bank and sovereign credit risk in the Eurozone, the so-called sovereign-bank nexus, is seen as a major threat for the stability of the Eurozone. This paper explores potential bank-level and country-level drivers of this relationship. We find that banks' home bias in their sovereign exposures and their low equity ratios as well as countries' high debt-to-GDP ratios and low perceived government effectiveness are positively related to the sovereign-bank nexus. While these results do not necessarily reflect causal relationships, they suggest that promoting banks' diversification of sovereign exposures could be an effective measure to mitigate the sovereign-bank nexus.

Keywords: sovereign-bank nexus; home bias; sovereign exposures; CDS spreads (search for similar items in EconPapers)
JEL-codes: G21 G28 (search for similar items in EconPapers)
Date: 2016
New Economics Papers: this item is included in nep-eec
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Persistent link: https://EconPapers.repec.org/RePEc:zbw:svrwwp:072016

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