OECD Journal: Financial Market Trends

Frequency :
Semiannual
ISSN :
1995-2872 (online)
ISSN :
1995-2864 (print)
DOI :
10.1787/19952872
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The twice-yearly journal from OECD providing timely analyses and statistics on financial matters of topical interest and longer-term developments in specific financial sectors. Each issue provides a brief update of trends and prospects in the international and major domestic financial markets along with articles covering such topics as structural and regulatory developments in OECD financial systems, trends in foreign direct investment, trends in privatization, and financial sector statistics covering areas such as bank profitability, insurance, and institutional investors.

Periodically, a small number of articles within one field of financial sector developments – constituting the so-called special focus for the particular issue – may be included.

Now published as part of the OECD Journal package.

Article
 

Sovereign and Banking Sector Debt

Interconnections through Guarantees You do not have access to this content

Authors:
Arturo Estrella, Sebastian Schich
Publication Date
23 Mar 2012
Pages
21
Bibliographic information
No.:
21,
Volume:
2011,
Issue:
2
Pages
21–45
DOI
10.1787/fmt-2011-5k9cswn0sfxt

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Sovereigns effectively provided the function of guarantor-of-last resort in response to the 2008/09 banking crisis, and recent bank funding challenges have led to renewed calls for explicit sovereign bank debt guarantees. The present paper focuses on the interconnections between the values of sovereign and bank debt that arise through sovereign guarantees for banks. We develop a valuation framework based on concepts of contingent claims analysis. In particular, we investigate the value of insurance of risky bank debt when the sovereign providing the guarantee can itself be risky. The framework is in principle applicable both to explicit and implicit guarantees and it is applied here to a measure of implicit external (mostly from the sovereign) support for the debt of a crosssection of 100 large European banks. Consistent with the model, the implicit support is higher, the lower the bank’s stand-alone creditworthiness and the higher the sovereign’s creditworthiness. These results have implications for pricing sovereign bank debt guarantees, be they provided individually by each sovereign for its domestic banks or by several sovereigns jointly. In the former case, stronger sovereigns should charge higher premiums for their bank debt guarantees for a given bank risk if the aim is to avoid creating distortions to competition. In the latter, they should receive greater allotments of premium incomes even where the share of the guarantees provided are identical among sovereigns.