Banking Soundness Indicators and Sovereign Risk in Time of Crisis: The Case of the European Union

22 Pages Posted: 8 Aug 2016

See all articles by Purificación Parrado-Martínez

Purificación Parrado-Martínez

Department of Financial Economics & Accounting. University of Jaén (Spain)

Antonio Partal-Ureña

University of Jaén

Pilar Gómez-Fernández-Aguado

University of Jaén

Date Written: August 2016

Abstract

This study examines the impact of the soundness of the banking sector on sovereign risk of EU member countries during the financial crisis using a selection of financial soundness indicators (FSIs) and the sovereign ratings of the three main rating agencies. Unlike previous literature that typically focuses on the ability of FSIs to foresee banking crises, we estimate ordered response models to assess the power of these indicators to explain sovereign risk. Our results show that evaluations made by the rating agencies are related to the lagged values of core FSIs such that an improvement in these indicators leads to improvements in upcoming sovereign ratings. Hence, reinforced banking soundness would reduce the sovereign risk. Accordingly, governments, supervisors and central banks should pay close attention to the evolution of certain FSIs related to the banking sector, in addition to other variables that have traditionally been taken into account in analysing sovereign risk.

Suggested Citation

Parrado-Martínez, Purificación and Partal-Ureña, Antonio and Gómez-Fernández-Aguado, Pilar, Banking Soundness Indicators and Sovereign Risk in Time of Crisis: The Case of the European Union (August 2016). The World Economy, Vol. 39, Issue 8, pp. 1172-1193, 2016, Available at SSRN: https://ssrn.com/abstract=2819240 or http://dx.doi.org/10.1111/twec.12357

Purificación Parrado-Martínez (Contact Author)

Department of Financial Economics & Accounting. University of Jaén (Spain) ( email )

Paraje Las Lagunillas, s/n
Jaén, Jaén 23071
Spain

Antonio Partal-Ureña

University of Jaén ( email )

23071 Jaen
Spain

Pilar Gómez-Fernández-Aguado

University of Jaén ( email )

23071 Jaen
Spain

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