A Zero-Risk Weight Channel of Sovereign Risk Spillovers
49 Pages Posted: 13 Feb 2014 Last revised: 18 Jun 2019
Date Written: June 17, 2019
European banks are exposed to a substantial amount of risky sovereign debt. “Missing capital” in the banking system resulting from the zero-risk weight exemption for European sovereign debt amplifies the co-movement between sovereign CDS spreads and facilitates cross-border crisis spillovers. Risks spill over from risky peripheral sovereigns to safer core countries, but not in the opposite direction nor for exposures to countries not exempted from risk-weighting. Unfunded non-domestic sovereign bond exposures primarily affect CDS spreads of non-GIIPS banks, while domestic sovereign-to-bank linkages are particularly important for GIIPS banks. Spillovers are attenuated when banks fund their sovereign bond exposures with capital.
Keywords: sovereign debt, sovereign risk, spillovers, bank risk, CDS, zero risk weight exemption
JEL Classification: G01, G21, G28
Suggested Citation: Suggested Citation