How Do Political Factors Shape the Bank Risk-Sovereign Risk Nexus in Emerging Markets?
Review of Development Economics,
This paper studies the role of political factors for determining the impact of banking sector distress on sovereign bond yield spreads for a sample of 19 emerging market economies in the period 1994–2013. Using interaction models, I find that the adverse impact of banking sector distress on sovereign solvency is less pronounced for countries with a high degree of political stability, a high level of power sharing within the government coalition, a low level of political constraint within the political system, and for countries run by powerful and effective governments. The electoral cycle pronounces the bank risk–sovereign risk transfer.
Banks and Sovereign Risk: A Granular View
Journal of Financial Stability,
We investigate the determinants of sovereign bond holdings of German banks and the implications of such holdings for bank risk. We use granular information on all German banks and all sovereign debt exposures in the years 2005–2013. As regards the determinants of sovereign bond holdings of banks, we find that these are larger for weakly capitalized banks, banks that are active on capital markets, and for large banks. Yet, only around two thirds of all German banks hold sovereign bonds. Macroeconomic fundamentals were significant drivers of sovereign bond holdings only after the collapse of Lehman Brothers. With the outbreak of the sovereign debt crisis, German banks reallocated their portfolios toward sovereigns with lower debt ratios and bonds with lower yields. With regard to the implications for bank risk, we find that low-risk government bonds decreased the risk of German banks, especially for savings and cooperative banks. Holdings of high-risk government bonds, in turn, increased the risk of commercial banks during the sovereign debt crisis.
Much Ado About Nothing: Sovereign Ratings and Government Bond Yields in the OECD
IWH Discussion Papers,
In this paper, we propose a new method to assess the impact of sovereign ratings on sovereign bond yields. We estimate the impulse response of the interest rate, following a change in the rating. Since ratings are ordinal and moreover extremely persistent, it proves difficult to estimate those impulse response functions using a VAR modeling ratings, yields and other macroeconomic indicators. However, given the highly stochastic nature of the precise timing of ratings, we can treat most rating adjustments as shocks. We thus no longer rely on a VAR for shock identification, making the estimation of the corresponding IRFs well suited for so called local projections – that is estimating impulse response functions through a series of separate direct forecasts over different horizons. Yet, the rare occurrence of ratings makes impulse response functions estimated through that procedure highly sensitive to individual observations, resulting in implausibly volatile impulse responses. We propose an augmentation to restrict jointly estimated local projections in a way that produces economically plausible impulse response functions.
The Political Determinants of Sovereign Bond Yield Spreads
Journal of International Money and Finance,
This paper analyzes the political determinants of sovereign bond yield spreads using data for 27 emerging markets in the period 1996 to 2009. I find strong evidence that countries with parliamentary systems (as opposed to presidential regimes) and a low quality of governance face higher sovereign yield spreads, while the degree of democracy and elections play no significant role. A higher degree of political stability and the power to implement austerity measures significantly reduce sovereign yield spreads particularly in autocratic regimes, while no significant effect is detected for democratic countries. Overall, political determinants have a more pronounced impact on sovereign bond yield spreads in autocratic and closed regimes than in democratic and open countries.
The Impact of Public Guarantees on Bank Risk-taking: Evidence from a Natural Experiment
Review of Finance,
In 2001, government guarantees for savings banks in Germany were removed following a lawsuit. We use this natural experiment to examine the effect of government guarantees on bank risk-taking. The results suggest that banks whose government guarantee was removed reduced credit risk by cutting off the riskiest borrowers from credit. Using a difference-in-differences approach we show that none of these effects are present in a control group of German banks to whom the guarantee was not applicable. Furthermore, savings banks adjusted their liabilities away from risk-sensitive debt instruments after the removal of the guarantee, while we do not observe this for the control group. We also document that yield spreads of savings banks’ bonds increased significantly right after the announcement of the decision to remove guarantees, while the yield spread of a sample of bonds issued by the control group remained unchanged. The evidence implies that public guarantees may be associated with substantial moral hazard effects.
Modelling Macroeconomic Risk: The Genesis of the European Debt Crisis
Diverging European sovereign bond yields after 2008 are the most visible sign of the European debt crisis. This dissertation examines in a first step, to which extent the development of yields is driven by credit and liquidity risk, and how it is influenced by general uncertainty on financial markets. It can be shown that yields are driven to a significant degree by a flight towards bonds of high liquidity in times of high market uncertainty. In a second step, high yields are interpreted as a sign of an existing crisis in the respective country. Using the signals approach, the early-warning capabilities of four different proposals for the design of the scoreboard as part of the “Macroeconomic Imbalances Procedure” (introduced in December 2011 by the European Commission) are tested, advocating a scoreboard including a variety of many different indicators. In a third step, the methodology of the signals approach is extended to include also results on significance.