European banks are exposed to a substantial amount of risky sovereign debt. “Missing capital” in the banking system resulting from the zero-risk weight exemption for European sovereign debt amplifies the co-movement between sovereign CDS spreads and facilitates cross-border crisis spillovers. Risks spill over from risky peripheral sovereigns to safer core countries, but not in the opposite direction nor for exposures to countries not exempted from risk-weighting. Unfunded non-domestic sovereign bond exposures primarily affect CDS spreads of non-GIIPS banks, while domestic sovereign-to-bank linkages are particularly important for GIIPS banks. Spillovers are attenuated when banks fund their sovereign bond exposures with capital.

Kirschenmann, Karolin, Josef Korte und Sascha Steffen (forthcoming), A zero-risk weight channel of sovereign risk spillovers, Journal of Financial Stability. Download

Autoren

Kirschenmann, Karolin
Korte, Josef
Steffen, Sascha

Schlagworte

Sovereign debt sovereign risk bank risk CDS contagion zero risk weight Basel III CRD EBA capital exercise