Investigating the Impact of Sovereign Interest Rates on Corporate Borrowing Costs in the Euro Area
Observatoire Français des Conjonctures Economiques (OFCE)
January 31, 2011
We analyze how public finances, through sovereign interest rates, impact corporate borrowing costs in the Euro Area. Theoretically, an increase in sovereign rates can have an impact on banks interest rates through three main channels: i) an increase in the risk free rate (price channel) ii) a decrease in the value of collateral held by the banks, which leads to an increase in their refinancing costs (liquidity channel) iii) a decrease in the mark-to-market value of the banks’ portfolio that reduces their solvency and as such may affect volumes and/or rates on credits (balance sheet channel).
In this paper we estimate the impact of sovereign rates on corporate borrowing costs in the Euro Area and in individual countries.
Due to the importance of banking credit in the financing of non-financial corporations (NFC) in the Euro Area, we rely mainly on bank lending rates to address this issue, using monthly data on interest rates on new and existing loans over the period January 2003-July 2010. Our results suggest that domestic sovereign rates have no significant effects on NFC borrowing costs through the price channel. The risk-free rate for loans seems more likely to be the swap rate. As such the existence of a unified refinancing market in the Euro Area, by reducing the link between domestic sovereign rates and rates on loans may have alleviate pressure on banks and on the corporate bond sector stemming from sovereign solvency issues. On the other hand, the liquidity channel seems to explain a part of the evolution of NFC interest rates, especially Peripheral countries.
For corporate bonds, we compute domestic bond indexes for six European countries and we find evidence of a price channel operating either through euro swap rates or domestic sovereign yields. This effect can be accounted by the fact that as asset prices, bond prices are more affected by markets developments.
Number of Pages in PDF File: 30
Keywords: Interest-rate pass-through, Euro Area countries, panel cointegration, sovereign interest rate
JEL Classification: C33, E43, E44, E50working papers series
Date posted: February 18, 2011 ; Last revised: February 23, 2011
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