The Sovereign-Bank Nexus in the Face of the COVID-19 Pandemic Outbreak—Evidence from EU Member States

Iustina Alina Boitan,Kamilla Marchewka-Bartkowiak

doi:10.3390/risks9050098

Iustina Alina Boitan, Kamilla Marchewka-Bartkowiak

Open Access

https://doi.org/10.3390/risks9050098

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Abstract

The major focus of this paper is on the sovereign–banks relationship following the COVID-19 pandemic crisis outbreak, with a view to gaining an insight into banks’ exposure to the sovereign. We rely on a series of complementary research approaches, such as desk research, comparative statistical analysis, exploratory learning algorithm, and a deterministic panel regression framework. The analysis reveals that most EU countries were not prepared for the pandemic crisis as they lacked a financial security buffer. The growing fiscal pressure and lockdown restrictions additionally resulted in an increase in banks’ exposure to the government debt market and higher government debt securities exposure on their balance sheets. One of the novelties of the research is the adoption of the gap method in order to measure the changes between banking assets major items (government securities vs. loans) and uncovering the preference for holding a specific type of asset. Additional insight is brought by the clustering solution, which shows increased cross-country heterogeneity in terms of the sovereign–banks relationship. Empirical research shows that banks’ involvement in the sovereign debt market is sensitive mainly to negative information related to pandemic occurrence and, to a lower extent, to positive information reflected by government’s reactions and economic stimulus measures. In addition, our results reveal there is no crowding-out effect triggered by the pandemic, in terms of lending to the sovereign against lending to the real economy. In the pandemic onset banks did not proceed to a sharp portfolio rebalancing in favor of the sovereign.

Highlights

The interplay between the banking system and the state through banks’ holding of government debt, still comes at the forefront of public and academic concerns, in the context of the current global pandemic
The specific research goal is to find out whether the strengthening of banks’ position on the government debt market is a direct consequence of the COVID-19 pandemic or whether it overlaps the existing structural domestic weaknesses of a country’s fiscal policy, which were exacerbated by the current health crisis
Empirical Results Regarding the Impact of the COVID-19 Pandemic. This part of the study attempts to answer the question whether the above-mentioned strengthening of banks’ position on the government debt market is a direct consequence of the COVID-19 pandemic or whether it overlaps the existing structural domestic weaknesses of a country’s fiscal policy, which were exacerbated by the current health crisis

Summary

Introduction

The interplay between the banking system and the state through banks’ holding of government debt, still comes at the forefront of public and academic concerns, in the context of the current global pandemic. The results from previous (before the pandemic crisis) analyses showed that commercial banks invest in debt securities issued by governments (bills and bonds) in order to meet liquid asset requirements, to obtain a stable interest income to offset other more volatile investments, to manage their short-term liquidity, and to take positions on the future movement of interest rates. Commercial banks use their government debt holdings to hedge their interest rate positions for repo transactions (in interbank money market and central bank operations). The sovereign–bank nexus defines the relationship between government debt and banks’ assets, playing a special role in times of crisis. It can reflect the interconnectedness between the health of the sovereign and the banking system, whereby stress in one sector may create and amplify stress in the other (Feyen and Zuccardi 2019). In the event that a country is unable or unwilling to repay its sovereign debt, due to countryspecific or systematic shocks, the banks that hold that debt will be in financial distress, and the sovereign risk can further translate into bank risk (Li and Zinna 2018)

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