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Sovereign Default Risk and Banks in a Monetary Union

32 Pages Posted: 13 Aug 2013 Last revised: 14 Aug 2013

Harald Uhlig

University of Chicago - Department of Economics

Multiple version iconThere are 4 versions of this paper

Date Written: August 12, 2013

Abstract

This paper seeks to understand the interplay between banks, bank regulation, sovereign default risk and central bank guarantees in a monetary union. I assume that banks can use sovereign bonds for repurchase agreements with a common central bank, and that their sovereign partially backs up any losses, should the banks not be able to repurchase the bonds. I argue that regulators in risky countries have an incentive to allow their banks to hold home risky bonds and risk defaults, while regulators in other "safe" countries will impose tighter regulation. As a result, governments in risky countries get to borrow more cheaply, effectively shifting the risk of some of the potential sovereign default losses on the common central bank.

Keywords: sovereign default risk, monetary union

Suggested Citation

Uhlig, Harald, Sovereign Default Risk and Banks in a Monetary Union (August 12, 2013). Becker Friedman Institute for Research in Economics Working Paper No. 2013-002. Available at SSRN: https://ssrn.com/abstract=2308939 or http://dx.doi.org/10.2139/ssrn.2308939

Harald Uhlig (Contact Author)

University of Chicago - Department of Economics ( email )

1101 East 58th Street
Chicago, IL 60637
United States

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