The evolving nexus: sovereigns, banks and NBFIs
Summary
Focus
Historically, banks' holdings of sovereign debt have been key drivers of the co-movement between sovereign and bank risks. Recent years have seen an increase in banks' links with non-bank financial institutions (NBFIs) as well as a greater presence of NBFIs in sovereign debt markets. These developments have the potential to broaden the classical sovereign-bank nexus into a sovereign-bank-NBFI nexus. We examine the degree to which this has taken place, using European bank-level data along with global country-level data.
Contribution
Our paper is the first to formally analyse whether there has been a fundamental change in the way sovereign risk is transmitted to the financial system. More concretely, we examine the degrees to which the co-movement between sovereign and bank risk is driven by banks' exposures to sovereigns and NBFIs. This has important implications for the analysis of the key risks facing the global financial system and for the policies needed to address them.
Findings
We find that banks' direct sovereign exposures have recently become less important in explaining the co-movement between bank and sovereign risk. By contrast, banks' exposures to NBFIs have become a significant determinant of the bank-sovereign risk co-movement. We also find evidence that NBFIs' sovereign debt holdings have become important drivers of the co-movement between NBFI and sovereign risk.
Abstract
This paper documents that the traditional sovereign-bank nexus has morphed into a broader nexus that now also includes non-bank financial institutions (NBFIs): the sovereign-bank-NBFI nexus. The classical sovereign-bank nexus has been a major financial stability concern following the eurozone crisis. Since then, sovereign debt levels have increased substantially in many major economies, while NBFIs' footprint in sovereign bond markets has grown significantly. This paper examines the transmis sion of risks among banks, sovereigns and NBFIs using European bank-level data and global country-level data. We find that banks' direct sovereign exposures have recently become less important in explaining the co-movement between bank and sovereign risk. By contrast, banks' exposures to NBFIs have become a significant determinant of the bank-sovereign risk co-movement. We also find evidence that NBFIs' sovereign debt holdings have become important drivers of the co-movement between NBFI and sovereign risk.
JEL Codes: F34, G01, G21, G23, H63
Keywords: banks, sovereign default, feedback loop, NBFI, nexus, risk
