Sovereign Debt Exposures and Bank CDS Spreads: Evidence from the European Debt Crisis
Raitanen, Mikko (2018)
2018
Kuvaus
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Tiivistelmä
This thesis analyses the impact of the GIIPS sovereign debt on European bank credit risk with particular interest on the recent European sovereign debt crisis. The thesis applies a panel data covering 33 banks in 12 countries in Europe at weekly frequency from November 2007 to December 2013. The purpose of this thesis is to examine whether and to what extent were the European banks exposed to sovereign credit risk from GIIPS countries. The thesis uses a GIIPS Bond Index variable as a measure of foreign debt exposure from peripheral sovereign countries. Moreover, this thesis also includes structural credit risk variables predicted by a structural model framework.
By using the Credit Default Swap (CDS) spreads as a measure of bank credit risk this thesis finds that bank CDS spreads were significantly affected by foreign debt exposure during the recent European sovereign debt crisis. Moreover, this thesis also shows that after the Greek government bailout in 2010 the influence of GIIPS sovereign debt on European bank credit risk decreased substantially. Furthermore, the empirical results also indicate that the variables predicted by structural models explain rather weakly the bank CDS spreads during the European sovereign debt crisis. However, the explanatory power of firm-specific factors, namely, leverage and equity volatility are rather poor excluding equity return. This result indicates that bank credit risk is driven mainly by macroeconomic and aggregate level factors rather than firm-specific factors.
Furthermore, the thesis proposes that banks with low levels of Tier 1 capital are particularly vulnerable to risk spillovers from the GIIPS sovereigns. Regulatory requirements give banks incentives to hold substantial amounts of foreign sovereign debt in their assets. Hence, significant exposures on risky peripheral debt in the bank assets might have adverse side-effects on the bank default risk, especially during a crisis when the creditworthiness of distressed sovereigns depreciates. The empirical results also provide evidence that there was a risk-shifting behaviour by the undercapitalized banks. In addition, this effect was more evident after the Greek government bailout in 2010.
By using the Credit Default Swap (CDS) spreads as a measure of bank credit risk this thesis finds that bank CDS spreads were significantly affected by foreign debt exposure during the recent European sovereign debt crisis. Moreover, this thesis also shows that after the Greek government bailout in 2010 the influence of GIIPS sovereign debt on European bank credit risk decreased substantially. Furthermore, the empirical results also indicate that the variables predicted by structural models explain rather weakly the bank CDS spreads during the European sovereign debt crisis. However, the explanatory power of firm-specific factors, namely, leverage and equity volatility are rather poor excluding equity return. This result indicates that bank credit risk is driven mainly by macroeconomic and aggregate level factors rather than firm-specific factors.
Furthermore, the thesis proposes that banks with low levels of Tier 1 capital are particularly vulnerable to risk spillovers from the GIIPS sovereigns. Regulatory requirements give banks incentives to hold substantial amounts of foreign sovereign debt in their assets. Hence, significant exposures on risky peripheral debt in the bank assets might have adverse side-effects on the bank default risk, especially during a crisis when the creditworthiness of distressed sovereigns depreciates. The empirical results also provide evidence that there was a risk-shifting behaviour by the undercapitalized banks. In addition, this effect was more evident after the Greek government bailout in 2010.