Domestic Sovereign Research Articles

The bright side of the doom loop: Banks’ sovereign exposure and default incentives

The feedback loop between sovereign and financial sector insolvency, termed the “doom loop”, was a key driver of the European debt crisis and motivated an array of policy proposals. This paper revisits the “doom loop” focusing on governments’ incentives to default. We introduce a 3-period model with strategic sovereign default, where debt is held by both domestic banks and foreign investors. The government maximizes domestic welfare; thus, the temptation to default increases with externally-held debt. Importantly, the cost of default arises endogenously from the damage that default causes to domestic banks’ balance sheets. Domestically-held debt thus serves as a commitment device for the government. We show that two prominent policy prescriptions – lower exposure of domestic banks to domestic sovereign debt or a commitment not to bailout banks – can backfire, since default incentives depend not only on the quantity of debt, but also on who holds it. Conversely, allowing domestic banks to buy additional domestic sovereign debt during times of sovereign distress can avert the doom loop. In the context of a monetary union similar unintended negative consequences may arise from a backstop by the central bank (e.g., the ECB’s Transmission Protection Instrument) if imprecisely calibrated or the pooling of debt (e.g., European safe bond, also known as ESBies).

Zero-risk weights and capital misallocation

Financial institutions, especially in Europe, hold a disproportionate amount of domestic sovereign debt. We examine the extent to which this home bias leads to capital misallocation in a real business cycle model with imperfect information and fiscal stress. We assume banks can hold sovereign debt according to a zero-risk weight policy and contrast this scenario to one in which banks weight the sovereign debt according to default probabilities. Banks are assumed to miscalculate the probability of a disaster state due to moral hazard and imperfect monitoring. This distortion pushes the economy away from the first-best allocation. We show that the zero risk weight policy exacerbates these distortions while a non-zero risk-weight improves allocations. The welfare costs associated with zero-risk weight policies are large. Households are willing to give up 3.2 percent of their consumption to move to the first-best allocation, whereas in the economy with non-zero risk-weights households are willing to give up only 1.2 percent of their consumption to move to the first-best allocation.

The role of financial market infrastructures in supporting a sustainable financial transition

This paper aims to describe the role of financial market infrastructures (FMIs), specifically central securities depositories (CSD) and international CSDs (iCSDs), in supporting a sustainable financial transition. It starts by laying out the central role of these FMIs in the centre of the financial value chain, where it plays a critical role in ensuring the smooth and efficient functioning, as well as stability of financial markets. FMIs operate multilateral technology systems and funnel vast amounts of data across multiple markets, including emerging markets and developing economies (EMDEs). The paper then highlights acute challenges in funding sustainability projects in those emerging markets and the need for solutions that help attract private capital and international investors. To help address some of these challenges, a case study is presented of Euroclearability and the establishment of efficient FMIs and secondary markets, drawing lessons from its current impact as a potential solution to bridge EMDE financing gap. A study of the impact of Euroclearability shows an average reduction in sovereign borrowing costs by 28bps, and 14bps for corporate borrowing costs. Additionally, Euroclearability is associated with greater liquidity in domestic sovereign bond markets, leading to higher trading volumes and lower bond yields in secondary markets. Finally, the paper delves briefly into the ways FMIs are well positioned to capture regulatory data flow and sustainability data. With strong track records in managing and quality-assuring data, FMIs can improve the processing of ESG metrics, such as regulatory disclosures, and facilitate the use of these new metrics between market participants.

Следите за руками. К вопросу об эксперименте по изменению структуры уровней высшего образования

Purpose.. To analyze the problem of reforming the structure of Russian higher education and the development in this regard the FSES of the fourth generation. Methodology: in the process of writing the following methods were used: analysis, synthesis, system approach, formal-legal. Conclusions. There are many questions to the reform of the structure of higher education levels, and they are of a fundamental nature; to find optimal answers to these questions a wide public discussion is required. This would confirm the fact that the state-public principle of management of the Russian education system, enshrined in legislation, is not a declaration, but a working reality. And it is important that this discussion should start now. The fundamental parameters of the concept of the domestic sovereign education system should be determined not after, but at the start of the experiment, in order to avoid the situation of a «cat in a bag». And the main question that requires a convincing answer: are we really forming a sovereign self-sufficient system of professional education, oriented to the interests of Russia? Or are we only imitating movement in this direction, in reality continuing to drift in the direction of foreign attitudes and hoping to get back in line to bow to Western «partners» who are now prepared to crucify Russia? Scientific and practical significance. The conducted study allows us to draw attention to the problem of Russian higher education reform and the search for a truly sovereign, nationally-oriented education system model.

Shifts in the portfolio holdings of euro area investors in the midst of COVID‐19: Looking‐through investment funds

AbstractWe study the impact of the COVID‐19 shock on the portfolio exposures of euro area investors. The analysis “looks‐through” holdings of investment fund shares to first gauge euro area investors' full exposures to global debt securities and listed shares by sector at end‐2019 and to subsequently analyse the portfolio shifts in the first and second quarters of 2020. We show heterogeneous patterns across asset classes and sectors, but also across less and more vulnerable euro area countries. In particular, we find a broad‐based rebalancing towards domestic sovereign debt at the expense of extra‐euro area sovereigns in the first quarter of 2020, consistent with heightened home bias, which however levelled off in the second quarter. On the contrary, for listed shares we find that euro area investors rebalanced away from domestic towards extra‐euro area securities in both the first and the second quarter, which may be associated with better relative foreign stock market performance. Many of these shifts were only due to indirect holdings, corroborating the importance of investment funds in assessing investors' exposures—especially for households, insurance companies and pension funds—in particular in times of large shocks. We also confirm the important intermediation role played by investment funds in an analysis focusing on the large‐scale portfolio rebalancing observed between 2015 and 2017 during the ECB's Asset Purchase Programme.

BRRD credibility and the bank-sovereign nexus

ABSTRACT We investigate the effectiveness of the Bank Recovery and Resolution Directive (BRRD) in mitigating the bank-sovereign nexus in the Euro Area. Using CDS spreads to measure bank and sovereign credit risk and a DCC-MIDAS model capturing the long-term component of bank-sovereign interconnectedness, we document that the dynamic correlation between banks and sovereigns has decreased in Euro Area countries since the introduction of the BRRD. Panel data analysis reveals that the decline in interconnectedness is not driven by the banks’ capital adequacy, size or holdings of domestic sovereign securities.

Optimal bailouts and the doom loop with a financial network

Banks usually hold large amounts of domestic debt which makes them vulnerable to their own sovereign’s default risk. At the same time, governments often resort to costly bailouts when their banking sector is in trouble. We investigate how the network structure and the distribution of sovereign debt ownership within the banking sector jointly affect the optimal bailout policy under this “doom loop”. We argue that rescuing banks with high domestic sovereign exposure is optimal if these banks are sufficiently central, even though that requires larger bailout expenditures than rescuing otherwise identical low-exposure banks. Our model illustrates how the “doom loop” exacerbates the “too interconnected to fail” problem.

Countering Informational Influences of the Russian Federation: National Experience

The urgency of the chosen issue is due to the fact that since the beginning of the hybrid aggression in 2014, the domestic information space has been subject to various interventions from Russia: from biased Russian media coverage of events in Ukraine to outright lies from the Russian authorities. At the same time, such attention to our state by Russia has led to the formation in Ukrainian society of a certain level of resistance to hostile information influences and the acquisition by domestic state and public institutions, as well as scientific circles of unique experience in countering Russia in this area. The methods of counteraction developed so far are quite diverse in nature, and therefore require critical evaluation in order to improve the foundations of information security of both Ukraine and the world democratic community. The purpose of this article is to assess the state of information security of the nation and to determine further directions for its improvement on the basis of a retrospective analysis of the process of counteracting Russian information influences on Ukrainian society and the state. Reflective approach was chosen as the main one to study the national experience of counteracting the information influences of the Russian Federation, as it provides an opportunity to comprehend Ukraine's experience as a purposeful and organized process of strengthening the resilience of domestic state and public institutions to clearly planned multilevel aggression and creation of the foundations for the development of own information space. A comparison of main information operations of the Russian Federation targeting Ukraine, of the described in the article stages of Russian aggression with the measures taken by the Ukrainian state and society gives an opportunity to allege that the crisis stage in the information struggle and the formation of domestic sovereign information space as a phenomenon is over. So, if at the early stages of information aggression the Kremlin relied on the attractiveness of its civilizational concepts, such as "Russian World" or "Moscow - Third Rome", which should have led to Russia's victory by "soft power", today we observe the change of course towards cluster influences, tendencies (problems in the Ukrainian energy sector, "anti-vaccination" campaigns, etc.) aimed at destabilizing the domestic political situation in the country and bringing discord in relations with foreign partners. Currently, the information campaigns of the Russian Federation from an individual phenomenon (operational line of hybrid war) have been transformed into secondary (service) tool of other areas of aggression: military, economic, etc. Under the difficult conditions of multifaceted opposition to the aggressor, Ukraine managed to create a basis for the development of its own information space and its protection from unfriendly influences not only of Russia but also of other potentially interested geopolitical actors. At the same time, both the state and society need to focus on further development of their own system of counteraction - to improve existing legislation, build appropriate institutions, form a scientific and methodological basis for the use of adequate and possibly asymmetric means of counteracting Russia.

Financing for the Post-pandemic Recovery: Developing Domestic Sovereign Debt Markets in Central America

The pandemic has urged countries around the globe to mobilize financing to support the recovery. This is even more relevant in Central America, where the policy response to cushion the pandemic’s economic and social impact has accentuated pre-existing debt vulnerabilities. This paper documents the potential for local currency bond markets to diversify and expand financing for the recovery, lowering bond yields, funding volatility, and exposure to global shocks. The paper further identifies priority actions, both national and regional, to support market development.

How the macroeconomic conditions and the global risk factors affect sovereign CDS spreads? New Evidence from Turkey

This paper aims to investigate the effects of a set of major country-specific macroeconomic variables and global risk factor on determining Turkey’s sovereign CDS spreads. The industrial production index, consumer price index, nominal exchange rates, policy interest rate, stock market index, and the volatility index as a proxy for global risk appetite are used by employing SVAR methodology with block exogeneity for 2011M01-2020M09 periods. The results reveal that the country's nominal exchange rate is the main driver of sovereign CDS spread. Especially in 2018, the most significant source of the high increase in sovereign CDS spreads is the exchange rates. According to the impulse response functions, to reduce the sovereign CDS spread, economic growth is more effective than the stock market return. Moreover, it is seen that the global risk factor does not play an essential role in the increases in domestic country's sovereign CDS spread.

Macroprudential Policy and the Sovereign-Bank Nexus in the Euro Area

We explore how changes in capital-based macroprudential regulation in the euro area affect the exposure of national banking sectors to domestic government debt, thus strengthening or weakening the sovereign-bank nexus. To do so, we construct a measure of macroprudential policy based on the Macroprudential Policy Evaluation Database (MaPPED) and estimate responses to the unsystematic component of macroprudential policy in panel vector autoregressive models for euro area ”core” and ”periphery” countries. Our main finding suggests that an unsystematic capital-based macroprudential policy tightening increases banks’ exposure to domestic sovereign bonds in the periphery countries and thus deepens the sovereign-bank nexus. By contrast, banks in the core countries expand their loan portfolios, rather than adjusting their domestic sovereign bond holdings, in response to the shock. We show that this result can be tied to the theoretical literature and investigate several transmission channels. Our results are highly robust to changes in the econometric set-up and the macroprudential indicator used.

Shifts in the Portfolio Holdings of Euro Area Investors in the Midst of COVID-19: Looking-Through Investment Funds

We study the impact of the COVID-19 shock on the portfolio exposures of euro area investors. The analysis “looks-through” holdings of investment fund shares to first gauge euro area investors' full exposures to global debt securities and listed shares by sector at end-2019 and to subsequently analyse the portfolio shifts in the first and second quarters of 2020. We show important heterogeneous patterns across asset classes and sectors, but also across euro area less and more vulnerable countries. In particular, we find a broad-based rebalancing towards domestic sovereign debt at the expense of extra-euro area sovereigns, consistent with heightened home bias. These patterns were strongly driven by indirect holdings – via investment funds – especially for insurance companies and pension funds, but levelled off in the second quarter. On the contrary, for listed shares we find that euro area investors rebalanced away from domestic towards extra-euro area securities in both the first and the second quarter, which may be associated with better relative foreign stock market performance. Many of these shifts were only due to indirect holdings, corroborating the importance of investment funds in assessing investors' exposures via securities, in particular in times of large shocks. We also confirm the important intermediation role played by investment funds in an analysis focusing on the large-scale portfolio rebalancing observed between 2015 and 2017 during the ECB's Asset Purchase Programme.

The Transnational Data Governance Problem

The historical paradigm of data globalization is fragmenting. Fragmentation of transnational data flows and related governance frameworks is emerging globally as the result of evolving differences between major economies, heightened by technological and geopolitical competition and conflicts. The irreconcilable positions of the three major economies and standard-setting jurisdictions – the United States, the European Union, and the People’s Republic of China – are breaking down the global data economy and threaten to fracture its core infrastructure, the Internet. We provide a framework to analyze this emerging landscape and assess its implications. Each jurisdiction is characterized by an evolving and distinct data governance style based on its attitude towards markets and governance, the normative principles supporting the exercise of control over data, and the mode of regulating data. As these domestic governance styles consolidate into competing and conflicting data governance regimes, their transnational export and impact are fracturing the existing transnational data governance paradigm, based on free data movement, and hindering international coordination in the global data economy. We characterize this dynamic as the wicked problem of transnational data governance, as no single solution can address it. The paper highlights three approaches to address this wicked problem: (1) a bilateral approach that draws from the riparian system for water rights; (2) a plurilateral approach allowing the free circulation data along sector-specific regulatory coalitions; (3) a multilateral approach, entailing a hard law Digital Bretton Woods or a soft law Digital Stability Board. The implementation of a combination of these approaches offers a basis for a workable foundation for transnational data governance that harnesses the benefits of data globalization without undermining domestic sovereign priorities.

Bank Capital Regulation and the Sovereign-Bank Nexus: Evidence from European Banks

European sovereign debt benefits from privileges in banking regulation throughout all risk categories. In contrast to the risk-based approach applied to other asset classes, it does not have to be backed by equity, can be fully financed by short-term, unstable funding sources, is treated as liquid as cash and is not subject to exposure limits, regardless of its actual riskiness. We explore the effects of these regulatory privileges on the co-variation between sovereign and bank sector credit risks–the so-called sovereign-bank nexus. Examining sovereign bond portfolios of large European banks between 2010 and 2020, we show that additional capital buffers stemming from non-zero sovereign risk weights would indeed weaken the sovereign-bank nexus and thus serve as a reasonable starting point for the future regulatory treatment of sovereign debt. However, the impact of banks' domestic sovereign exposures is state-dependent and the sovereign-bank nexus is not strongest for banks with the highest risk-weighted sovereign exposures. As a result, the impact of capital requirements based on traditional risk-weighting schemes would be limited.

Drivers of Sovereign Bond Yields in India

This study analyzed the behavior of the ten-year nominal sovereign bond yield in India with respect to a host of factors, especially for a decade when economic growth alters considerably with time. The vector autoregression methodology (VAR) was applied to the monthly data of economic and financial variables from January 2012 to March 2020. The findings suggested that long-run sovereign bond yield behavior was primarily driven by domestic fundamentals, including money market fundamentals. A rise in the 91-day treasury bill lagged the value of the bond yield, and inflation exert significant upward pressure on the ten year domestic sovereign bond yields. International factors such as exchange rate and crude oil price exert significant but mild influence. Another finding was affirmed that short-term domestic bond yield movements significantly determined long-run domestic bond yields. From an overall policy perspective, it becomes important to maintain domestic economic stability to manage fiscal and debt sustainability.

Financing for the Post-Pandemic Recovery: Developing Domestic Sovereign Debt Markets in Central America

Financing for the Post-Pandemic Recovery: Developing Domestic Sovereign Debt Markets in Central America

Global Demand for Basket-Backed Stablecoins

We develop a model where persistent trade shocks create demand for a basket- backed stablecoin, such as Mark Carney's "synthetic hegemonic currency" or Facebook's recent proposal for Libra. In numerical simulations, we find four main results. First, because of general equilibrium effects of the basket currency on the volatility of currency values, overall demand for that currency is small. Second, despite scant holdings of the basket, its global reach may contribute to substantial increases in welfare if the basket is widely accepted, allowing it to complement holdings of sovereign currencies. Third, we calculate the welfare maximizing composition of the basket, finding that optimal weights depend on the pattern of international acceptance, but that basket composition does not significantly affect welfare. Fourth, despite potential welfare improvements, low demand for the basket currency from buyers limits sellers' incentives to invest in accepting it, suggesting that fears of a so-called global stablecoin replacing domestic sovereign currencies may be overstated.

Barbados sovereign debt restructuring 2018–2019—like the island, small but perfectly formed

The Caribbean is no stranger to sovereign debt restructurings. It is hard to imagine another region of the world with a higher ratio of GDRs per capita. In only the last ten years (a blink of an eye in sovereign debt years), each of Antigua and Barbuda, Belize, Grenada and St Kitts and Nevis have undergone debt restructurings and Jamaica has done so twice. So what is newsworthy about the debt restructuring just completed by Barbados? There are two significant “firsts”, as will be described in more detail in this article: - first use in the Caribbean of local law legislation to introduce a class voting system across exiting local law sovereign bonds, a la Greece ; and - first country to take advantage of a re-papering of the terms of its domestic and foreign sovereign debt to include a “natural disaster” clause to enable the deferral of debt service costs in the event of significant damage caused by a natural disaster. Barbados is, economically, in a relatively privileged position within the Caribbean. Its GDP per capita is in the same IMF bracket as Portugal and Mexico and three and four times than the GDP per capital of Dominica and Jamaica, respectively . Geographically too, Barbados is in a relatively privileged position. It stands out on its own, about 150kms east of the crescent of islands that make up the Windward Islands and Leeward Islands, known collectively as the Lesser Antilles. It’s latitude makes it one of the more southerly of the Lesser Antilles, which is believed to make the island less at risk of hurricane damage than more northerly islands. However, Barbados’ privileged position made it particularly vulnerable to the financial storm that followed the global financial crisis. As a service provider of higher end Caribbean vacations, Barbados was particularly impacted by the downturn in vacation spending by those in the UK, US and Europe whose disposable income had been constrained by the financial crisis. As one of the wealthier countries in the Caribbean, international private creditors had been keen to provide loans and buys bonds issued by Barbados in the boom years leading up to the financial crisis. Even before the fall in GDP per capita that coincided with the financial crisis, the debt to GDP of Barbados had been rising precipitously from 53.8% in 1999 to 100% in 2009. By the time prime minister Mia Mottley swept into government following a landslide election victory in May 2018 (in which her party won all 30 seats in the Barbados parliament), the island’s debt to GDP had reached 175% including arrears. With characteristic decisiveness, immediately on entering office Ms Mottley announced that there would be a restructuring of the country’s debts.

Unconventional Monetary Policy Shocks in the Euro Area and the Sovereign-Bank Nexus

We explore the effects of the ECB’s unconventional monetary policy on the banks’ sovereign debt portfolios. In particular, using panel vector autoregressive (VAR) models we analyze whether banks increased their domestic government bond holdings in response to non-standard monetary policy shocks, thereby possibly promoting the sovereign-bank nexus, i.e. the exposure of banks to the debt issued by the national government. Our results suggest that euro area crisis countries’ banks enlarged their exposure to domestic sovereign debt after innovations related to unconventional monetary policy. Moreover, the restructuring of sovereign debt portfolios was characterized by a home bias.

Optimal Bailouts and the Doom Loop with a Financial Network

Banks usually hold large amounts of domestic public debt which makes them vulnerable to their own sovereign’s default risk. At the same time, governments often resort to costly public bailouts when their domestic banking sector is in trouble. We investigate how the interbank network structure and the distribution of sovereign debt holdings jointly affect the optimal bailout policy in the presence of this doom loop. Rescuing banks with high domestic sovereign exposure is optimal if these banks are sufficiently central in the network, even though that requires larger bailout expenditures than rescuing low-exposure banks. Our findings imply that highly central banks can use exposure to their own government as a strategic tool to increase the likelihood of being bailed out. Our model thus illustrates how the doom loop exacerbates the too interconnected to fail problem in banking. Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.