Sovereigns and Financial Intermediaries Spillovers
34 Pages Posted: 8 Apr 2019
Date Written: February 2019
We examine the spillover effects between sovereigns and banks in a model with a heterogeneous banking system. An increase in sovereign's default risk affects financial intermediaries through two channels in this model. First, banks' funding costs might increase, inducing higher interest rates on loans and bonds and a cut back in these assets. Second, financial regulator's risk-weighted asset framework would assign higher weights to lower quality assets, implying a portfolio rebalancing and more deleveraging. While capital adequacy requirements weaken the impact of shocks emerging from the real economy, they amplify the effect of shocks on banks' balance sheets.
Keywords: Central banks, Interest rates on loans, Bank capital, Market interest rates, Bank liquidity, Sovereign risk, Contagion, Interbank market, interbank, deposit rate, leverage ratio, order condition, bank 's balance
JEL Classification: H63, F34, G15, E01, G21, E52, E62, G12
Suggested Citation: Suggested Citation