Thursday, September 12, 2013

The impact of sovereign credit risk on bank funding conditions

The impact of sovereign credit risk on bank funding conditionsCommittee on the Global Financial System CGFS Papers No 43 The impact of sovereign credit risk on bank funding conditions Report submitted by a Study Group established by the Committee on the Global Financial System This Study Group was chaired by Fabio Panetta of the Bank of Italy July 2011 JEL classification: E58, E60, G21 Copies of publications are available from: Bank for International Settlements Communications CH-4002 Basel, Switzerland E-mail: publications@bis.org Fax: +41 61 280 9100 and +41 61 280 8100 This publication is available on the BIS website (www.bis.org). © Bank for International Settlements 2011. All rights reserved. Brief excerpts may be reproduced or translated provided the source is cited. ISBN 92-9131-879-5 (print) ISBN 92-9197-879-5 (online) CGFS – The

impact of sovereign credit risk on bank funding conditions iii Preface In late 2010, the Committee on the Global Financial System (CGFS) established a Study Group to examine the relationship between sovereign credit risk and bank funding conditions, how banks might respond to an environment of ongoing elevated sovereign risk and the implications for policymakers. This is an important topic, as sovereign credit risk is already a significant issue for European banks, and over coming years may have implications for global financial stability. The Study Group was chaired by Fabio Panetta of the Bank of Italy. The report was finalised in early June 2011, and presented to central bank Governors at the Global Economy Meeting later that month, where it received endorsement for publication. We hope that this report will be a relevant and timely input to national and international discussions about managing the current circumstances of economic and financial strain. Mark Carney Chairman, Committee on the Global Financial System Governor, Bank of Canada CGFS – The impact of sovereign credit risk on bank funding conditions v Contents Preface.....................................................................................................................................iii Introduction and executive summary........................................................................................1 1. The deterioration in sovereigns’ perceived creditworthiness ..........................................3 2. Broad trends in the composition and cost of banks’ funding...........................................4 2.1 Composition of bank funding .................................................................................5 2.2 Banks’ funding costs..............................................................................................8 3. Transmission channels .................................................................................................13 3.1 Asset holdings .....................................................................................................13 3.2 The collateral/liquidity channel.............................................................................17 3.3 Sovereign ratings and bank ratings .....................................................................20 3.4 Effects of government guarantees on bank funding ............................................21 3.5 International spillovers .........................................................................................25 3.6 Risk aversion channel..........................................................................................27 3.7 Impact on banks’ non-interest income .................................................................27 3.8 Crowding-out effects on banking sector debt issuance .......................................28 3.9 Hedging strategy of sovereign exposure with the iTraxx Financial Index............28 4. Discussion of results and conclusions ..........................................................................29 4.1 Bank funding structure and transmission channels: main findings ......................29 4.2 Implications for banks ..........................................................................................30 4.3 Possible policy implications .................................................................................31 References.............................................................................................................................34 Annex 1 Spillovers from banks to sovereigns and possible feedback loops ..........................37 Annex 2 How previous sovereign crises have affected banks ...............................................38 Annex 3 A timeline of key sovereign debt events...................................................................40 Annex 4 Graphical appendix ..................................................................................................42 Annex 5 Study Group members.............................................................................................45 CGFS – The impact of sovereign credit risk on bank funding conditions 1 Introduction and executive summary The financial crisis and the ensuing recession have caused a sharp deterioration in public finances across advanced economies, raising investor concerns about sovereign risk. The concerns have so far mainly affected the euro area, where some countries have seen...

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