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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.

Chart_Chiara

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 is a Senior fellow at Bruegel. He is also a Professor of Public Policy and Economics at the Willy Brandt School of Public Policy. From 2022-2024, he was the Director and CEO of the German Council on Foreign Relations (DGAP) and from 2013-22 the director of Bruegel. Over his career, he has contributed to research on European political economy, climate policy, geoeconomics, macroeconomics and foreign affairs. His work was published in academic journals such as Nature, Science, Research Policy, Energy Policy, Climate Policy, Journal of European Public Policy, Journal of Banking and Finance. His co-authored book “The macroeconomics of decarbonization” is published in Cambridge University Press.

    An experienced public adviser, he has been testifying twice a year since 2013 to the informal European finance ministers’ and central bank governors’ ECOFIN Council meeting on a large variety of topics. He also regularly testifies to the European Parliament, the Bundestag and speaks to corporate boards. In 2020, Business Insider ranked him one of the 28 most influential “power players” in Europe. 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 member and co-director to the G20 High level independent panel on pandemic prevention, preparedness and response under the co-chairs Tharman Shanmugaratnam, Lawrence H. Summers and Ngozi Okonjo-Iweala. From 2013-22, he was an advisor to the Mastercard Centre for Inclusive Growth. He is a member of the Bulgarian Council of Economic Analysis, the European Council on Foreign Affairs and  advisory board of Elcano.

    Guntram 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 worked in the research department at the Bundesbank, which he joined after completing his PhD in economics at the University of Bonn. He also worked as an external adviser to the International Monetary Fund. He is fluent in German, English, and French. His work is regularly published and cited in leading media. 

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