NDLI: Sovereign and Banking Sector Debt. Interconnections through Guarantees.

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Sovereign and Banking Sector Debt. Interconnections through Guarantees.

Content Provider	OECD iLibrary
Author	Estrella, Arturo Schich, Sebastian
Abstract	Sovereigns effectively provided the function of guarantor-of-last resort in response to the 2008/09 banking crisis, and recent bank funding challenges have led to renewed calls for explicit sovereign bank debt guarantees. The present paper focuses on the interconnections between the values of sovereign and bank debt that arise through sovereign guarantees for banks. We develop a valuation framework based on concepts of contingent claims analysis. In particular, we investigate the value of insurance of risky bank debt when the sovereign providing the guarantee can itself be risky. The framework is in principle applicable both to explicit and implicit guarantees and it is applied here to a measure of implicit external (mostly from the sovereign) support for the debt of a crosssection of 100 large European banks. Consistent with the model, the implicit support is higher, the lower the bank’s stand-alone creditworthiness and the higher the sovereign’s creditworthiness. These results have implications for pricing sovereign bank debt guarantees, be they provided individually by each sovereign for its domestic banks or by several sovereigns jointly. In the former case, stronger sovereigns should charge higher premiums for their bank debt guarantees for a given bank risk if the aim is to avoid creating distortions to competition. In the latter, they should receive greater allotments of premium incomes even where the share of the guarantees provided are identical among sovereigns.
Page Count	25
Starting Page	21
Ending Page	45
Volume Number	2011
Issue Number	2
Language	English
Publisher	OECD Publishing
Publisher Date	2012-03-23
Access Restriction	Open
Subject Keyword	Finance and Investment
Content Type	Text
Resource Type	Article

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