Banking Crises and Sovereign Defaults in Emerging Markets: Exploring the Links

Abstract

This paper provides a set of stylised facts on the mechanisms through which banking and sovereign distress feed into each other, using a large sample of emerging economies over three decades. We first define as events where banking crises and sovereign defaults combine, and further distinguish between those banking crises that end in sovereign debt crises, and vice-versa. We then assess what differentiates single episodes from twin ones. Using an event analysis methodology, we study the behaviour around crises of variables describing the balance sheet interconnection between the banking and public sectors, the characteristics of the banking sector, the state of public finances and the macroeconomic context. We find that there are systematic differences between single and twin crises across all these dimensions. Additionally, we find that twin crises are heterogeneous events: taking into account the proper time sequence of crises within twin episodes is important for understanding their drivers, transmission channels and economic consequences. Our results shed light on the mechanisms surrounding feedback loops of sovereign and banking stress.