Does Quantitative Easing Mitigate the Sovereign-Bank Nexus?
38 Pages Posted: 8 Jan 2021
Date Written: January 6, 2021
The credit risk of the sovereign affects the financial health of its banking sector and vice versa, creating an adverse feedback loop known as “sovereign- bank nexus”. We show that Quantitative Easing can effectively mitigate the sovereign-bank nexus. Our results indicate that the ECB’s Public Sector Purchase Programme reduced the co-movement of sovereign and bank credit risk by almost 80%. The mitigation is driven by the euro area periphery and works through three channels: (i) a reduction in government bond holdings of banks, (ii) an increase of government bond prices, and (iii) an increase in excess liquidity holdings of banks.
Keywords: Sovereign-bank nexus, quantitative easing, Public Sector Purchase Programme, financial stability
JEL Classification: E52, G10, E60, G21
Suggested Citation: Suggested Citation