The Quest for Banking Stability in the Euro Area: The Role of Government Interventions

46 Pages Posted: 27 Jul 2014 Last revised: 15 Jan 2017

See all articles by Renatas Kizys

Renatas Kizys

Southampton Business School

Nikos Paltalidis

Durham University Business School

Konstantinos P. Vergos

University of Portsmouth - Portsmouth Business School

Date Written: December 14, 2016

Abstract

We build upon a Markov-Switching Bayesian Vector Autoregression (MSBVAR) model to study how the credit default swaps market in the euro area becomes an important chain in the propagation of shocks through the entire financial system. The study sheds light on the regime-dependent interconnectedness between the risk of investing in banking and public sector bonds and provides novel evidence that a rise in sovereign debt, due to the countercyclical fiscal policy measures, is perceived by stock market investors as a burden on growth prospects. We also document that government interventions in the banking sector deteriorate the credit risk of sovereign debt. Higher risk premium required by investors for holding riskier government bonds depresses the sovereign debt market, it impairs banks’ balance sheets, and it depresses the collateral value of loans leading to bank retrenchment. The ensuing two-way banking-fiscal feedback loop indicates that government interventions do not necessarily stabilize the banking sector.

Keywords: Banking Stability, Credit Default Swaps, Government Interventions, Markov Switching Bayesian Vector Autoregression, Sovereign Debt, Stock Market

JEL Classification: C11, C58, G01, G21, G28

Suggested Citation

Kizys, Renatas and Paltalidis, Nikos and Vergos, Konstantinos, The Quest for Banking Stability in the Euro Area: The Role of Government Interventions (December 14, 2016). Journal of International Financial Markets, Institutions and Money, Vol. 40, pp. 111-133, January 2016, Available at SSRN: https://ssrn.com/abstract=2471752 or http://dx.doi.org/10.2139/ssrn.2471752

Renatas Kizys (Contact Author)

Southampton Business School ( email )

Room 1013, Building 4
Highfield Campus
Southampton, SO17 1BJ
United Kingdom
+442380598612 (Phone)

Nikos Paltalidis

Durham University Business School ( email )

Mill Hill Lane
Durham, Durham DH1 3LB
United Kingdom

Konstantinos Vergos

University of Portsmouth - Portsmouth Business School ( email )

Portland Street
Portsmouth, Hampshire P01 3DE
United Kingdom

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