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Chart of the week: banking and sovereign risk: is it banks’ holding of government debt or banks’ location?

Since the start of the European sovereign debt crisis, the interdependence between banks and sovereign risk has been emphasised. This week's chart s

Publishing date
29 March 2012

Since the start of the European sovereign debt crisis, the interdependence between banks and sovereign risk has been emphasised. The figure below shows the positive correlation between sovereign and bank credit default swaps (CDS) for a number of euro-area countries during 2011.


Source: Bruegel calculations with data from Datastream and Macrobond.

Note: Weekly averages from January 2011 to February2012. Banking CDS by country are calculated as weighted averages of CDS of the individual banks considered for each country. The graph for Greece is not displayed since it is characterised by hyperbolic pattern.

A recent article in the FT suggests that this deadly link between sovereign and banking risk has become worse due to increased government bond purchases following the LTRO, see our post of yesterday on the topic. In our recent paper we study a sample of banks across Europe. The evidence suggests that government bond holdings of banks may not be the main reason for the strong correlation of risk. In fact, we show only a relatively weak correlation between the banks’ risk or stock market performance and their holdings of government debt. In other words, a bank in - say Spain – has lost market value in 2011 but the loss was equally high for a bank holding a lot or very little Spanish government debt. We also find that such a correlation exists even in Germany and France.

These empirical findings suggest that the channel of banks’ holdings of sovereign debt poorly explains the sovereign-banking link. Rather, the location of banks plays a prominent role for their performance in financial markets. Thus, addressing this perceived country risk at euro area level requires the creation of a common guarantee mechanism for European banks: in other words, a banking union.

About the authors

  • Guntram B. Wolff

    Guntram Wolff was the Director of Bruegel. Over his career, he has contributed to research on European political economy and governance, fiscal, monetary and financial policy, climate change and geoeconomics. Under his leadership, Bruegel has been regularly ranked among the top global think tanks and has grown in influence and impact with a team of now almost 40 recognized scholars and around 65 total staff. Bruegel is also recognized for its outstanding transparency.

    A recognized thought leader and academic, he regularly testifies at the European Finance Ministers' ECOFIN meeting, the European Parliament, the German Parliament (Bundestag) and the French Parliament (Assemblée Nationale). From 2012-16, he was a member of the French prime minister's Conseil d'Analyse Economique. In 2018, then IMF managing director Christine Lagarde appointed him to the external advisory group on surveillance to review the Fund’s priorities. In 2021, he was appointed to the G20 high level independent panel on pandemic prevention, preparedness and response. He is also a professor (part-time) at the Solvay Brussels School of Université Libre de Bruxelles, where he teaches economics of European integration.

    He joined Bruegel from the European Commission, where he worked on the macroeconomics of the euro area and the reform of euro area governance. Prior to joining the Commission, he was coordinating the research team on fiscal policy at Deutsche Bundesbank. He also worked as an external adviser to the International Monetary Fund.

    He holds a PhD in economics from the University of Bonn and studied in Bonn, Toulouse, Pittsburgh and Passau. He taught economics at the University of Pittsburgh and at Université libre de Bruxelles. He has published numerous papers in leading academic journals. His columns and policy work are published and cited in leading international media and policy outlets. Guntram is fluent in German, English, French and has good notions of Bulgarian and Spanish.

Related content

Working paper

Greeniums in sovereign bond markets

In this paper, we analyse whether green sovereign bonds are systematically priced differently to conventional sovereign bonds in the secondary markets

Monika Grzegorczyk and Guntram B. Wolff