The zero risk fallacy? Banks' sovereign exposure and sovereign risk spillovers

Karolin Kirschenmann, Josef Korte and Sascha Steffen

No 17-069, ZEW Discussion Papers from ZEW - Leibniz Centre for European Economic Research

Abstract: European banks are exposed to a substantial amount of risky sovereign debt. The "missing bank capital" resulting from the zero-risk weight exemption for European banks for European sovereign debt amplifies the co-movement between sovereign CDS spreads and facilitates cross-border financial-crisis spillovers. Risks spill over from risky periphery sovereigns to safer core countries, but not in the opposite direction nor for exposures to countries not exempted from risk-weighting. We consider the trade-off of benefits of sovereign debt (for banks and sovereigns) and spillover risk when applying risk-weights. More bank capital as well as positive risk-weighting for sovereign exposures mitigates spillovers.

Keywords: sovereign debt; sovereign risk; bank risk; CDS; contagion; zero risk weight; Basel III; CRD; EBA capital exercise (search for similar items in EconPapers)
JEL-codes: F23 G01 G14 G15 G21 G28 (search for similar items in EconPapers)
Date: 2017
New Economics Papers: this item is included in nep-eec and nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (11)

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Persistent link: https://EconPapers.repec.org/RePEc:zbw:zewdip:17069

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