The relationship between sovereign risk and bank risk

Abstract

This dissertation aims to empirically analyze the relationship between Bank Risk and Sovereign Risk. Simultaneously, and controlling for micro and macroeconomic variables, it also examines the impact of both the financial crisis and the first Covered Bond Purchase Programme launched by the European Central Bank on bank bond credit spreads. Using a sample of 16,860 bonds – 10,920 Covered Bonds; 5,695 Bank Bonds; and 245 Securitization Bonds - issued by Western European banks between January 1, 2000 and December 31, 2011, we found that: (i) the 2007/2008 financial crisis had a significant impact on banking risk, because it led to a rise of banks’ funding costs, as the spreads paid at time of issuance increased substantially; (ii) the sovereign risk affects the bonds spreads , after controlling micro and macroeconomic variables;(iii) specially in times of financial distress, sovereign and bank risk relationship becomes more tight. This effect affects more specifically Covered Bonds (CB) and Bank Bonds (BB), but not Securitization Bonds (SB). To measure sovereign risk, we used three proxies: Rating, Credit Default Swaps (CDS) and Government Bond Yields. We also concluded that CDS are the sovereign risk proxy that influences more significantly bond spreads; countries with better soundness provide a safety net to “their banks” in times of financial crisis; and the ECB Covered Bond Purchase Programme fulfilled their main goals leading to a decrease in credit spreads. However, with the appearance of the Sovereign Debt Crisis, the effects started to fade. For robustness tests, we used bank’s accounting and financial ratios, and the results proved to be the same.

Date of Award	6 Jul 2016
Original language	English
Awarding Institution	Universidade Católica Portuguesa
Supervisor	João Pinto (Supervisor)