Open AccessSovereign Defaults and Banking Crises
Author(s) -
Kanat Isakov
Publication year - 2021
Publication title -
žurnal èkonomičeskoj teorii
Language(s) - English
Resource type - Journals
ISSN - 2073-6517
DOI - 10.31063/2073-6517/2021.18-1.2
Subject(s) - default , sovereign default , bond , monetary economics , financial system , sovereignty , maturity (psychological) , european debt crisis , economics , credit risk , debt , business , sovereign debt , finance , international economics , european integration , european union , political science , politics , law
This research is aimed at contributing to the endogenization of default costs. Higher exposure of a banking system to sovereign bonds increases the likelihood of banking panics due to sovereign defaults. Following (Gertler, Kiyotaki, 2015), the research models the possibility of a banking crisis occurring after a sovereign default. While a higher exposure of a banking system is associated with potential losses, this mechanism creates a stronger commitment to honor the sovereign debt. A marginal increase in the sovereign debt raises the ex-post costs of default through a higher likelihood of a banking crisis, thus making a default option less desirable. This mechanism might increase investors’ confidence and resolve the coordination problem of self-fulfilling crises. In part, this may explain the findings of Bocola and Dovis (2019), who claim that non-fundamental risk played only a limited role during the European sovereign debt crisis. Furthermore, as opposed to the standard solution of the coordination problem — to issue debt of longer maturity — a government can resolve this problem by forcing its banking system to hold more sovereign bonds.