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Bank capital, government bond holdings, and sovereign debt capacity

Matteo Crosignani ()

Journal of Financial Economics, 2021, vol. 141, issue 2, 693-704

Abstract: I develop a model where the sovereign debt capacity depends on the capitalization of domestic banks. Low-capital banks optimally tilt their government bond portfolio toward domestic securities, linking their destiny to that of the sovereign. If the sovereign risk is sufficiently high, low-capital banks lend less to the productive sector to further increase their holdings of domestic government bonds, lowering sovereign yields. In this case, a government that regulates bank capital faces a trade-off. On the one hand, high-capital banks lend more to the productive sector. On the other hand, low-capital banks support the home sovereign debt capacity.

Keywords: Bank capital; Sovereign risk; Government bonds; Bank-Sovereign nexus (search for similar items in EconPapers)
JEL-codes: E44 F33 G21 G28 (search for similar items in EconPapers)
Date: 2021
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jfinec:v:141:y:2021:i:2:p:693-704

DOI: 10.1016/j.jfineco.2021.04.005

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