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1、The Sovereign-Bank Nexus in Emerging Markets in the Wake of the COVID-19 Pandemic Prepared by Andrea Deghi,Salih Fendoglu,Tara Iyer,Hamid Reza Tabarraei,Yizhi Xu and Mustafa Y.Yenice WP/WP/22/223 IMF Working Papers describe research in progress by the author(s)and are published to elicit comments an
2、d to encourage debate.The views expressed in IMF Working Papers are those of the author(s)and do not necessarily represent the views of the IMF,its Executive Board,or IMF management.2022 NOV*The authors are very grateful for comments by Viral Acharya,Tobias Adrian,Fabio Natalucci,Mahvash Qureshi,Jrm
3、eVandenbussche and seminar participants at the International Monetary Fund,the Association of Supervisors of Banks of theAmericas(ASBA),Central Bank of Colombia,Yale Financial Stability Program,The Hong Kong Monetary Authority,The Monetary Authority of Singapore,and The Joint Vienna Institute.Oksana
4、 Khadarina and Dmitry Yakovlev provided outstanding research assistance.2022 International Monetary Fund WP/22/223IMF Working Paper Monetary and Capital Markets Department The Sovereign-Bank Nexus in Emerging Markets in the Wake of the COVID-19 Pandemic Prepared by Andrea Deghi,Salih Fendoglu,Tara I
5、yer,Hamid Reza Tabarraei,Yizhi Xu,and Mustafa Yasin Yenice*Authorized for distribution by Mahvash Qureshi November 2022 IMF Working Papers describe research in progress by the author(s)and are published to elicit comments and to encourage debate.The views expressed in IMF Working Papers are those of
6、 the author(s)and do not necessarily represent the views of the IMF,its Executive Board,or IMF management.ABSTRACT:The COVID-19 pandemic has brought the relationship between sovereigns and banksthe so-called sovereign-bank nexusin emerging market economies to the fore as bank holdings of domestic so
7、vereign debt have surged.This paper examines the empirical relevance of this nexus to assess how it could amplify macro-financial stability risks.The findings show that an increase in sovereign credit risk can adversely affect banks balance sheets and credit supply,especially in countries with less-
8、well-capitalized banking systems.Sovereign distress can also impact banks indirectly through the nonfinancial corporate sector by constraining their funding and reducing their capital expenditure.Notably,the effects on banks and corporates are strongly nonlinear in the size of the sovereign distress
9、.JEL Classification Numbers:E44,F34,F65,G21 Keywords:Sovereign-bank nexus;emerging markets;financial stability;sovereign risk;COVID-19;banking sector;corporate investment Authors E-Mail Address:ADeghiimf.org;SFendogluimf.org;HTabarraeiimf.org;TIyerimf.org;YXuimf.org;MYeniceimf.org WORKING PAPERS The
10、 Sovereign-Bank Nexus in Emerging Markets in the Wake of the COVID-19 Pandemic Prepared by Andrea Deghi,Salih Fendoglu,Tara Iyer,Hamid Reza Tabarraei,Yizhi Xu,and Mustafa Yasin Yenice IMF WORKING PAPERS The Sovereign-Bank Nexus in Emerging Markets in the Wake of the COVID-19 Pandemic INTERNATIONAL M
11、ONETARY FUND 2 Contents I.INTRODUCTION _ 4 II.CONCEPTUAL FRAMEWORK _ 5 III.DEVELOPMENTS IN THE SOVEREIGN-BANK NEXUS IN EMERGING MARKETS:SOME STYLIZED FACTS _ 8 IV.EVALUATING THE STRENGTH OF THE NEXUS _ 10 V.AN EMPIRICAL EVALUATION OF THE TRANSMISSION MECHANISMS _ 12 A.Sovereign Exposure Channel _ 12
12、 B.Safety Net Channel_ 167 C.Macroeconomic Channel _ 21 VI.CONCLUSIONS _ 266 REFERENCES _ 267 FIGURES Figure 1 Key Channels of the Sovereign-Bank Adverse Feedback Loop _ 6 Figure 2.Developments in Emerging Market Public Debt and Banks Sovereign Exposures _ 9 Figure 3.Transmission of Risks through th
13、e Sovereign-Bank Nexus:Strength of the Main Channels across Emerging Markets_ 11 Figure 4.Transmission of Sovereign Risk through the Exposure Channel _ 155 Figure 5.Stylized Facts on Bank Support Rating Floor in Emerging Markets _ 17 Figure 6.The Effect of Safety Nets on Banks Returns following Sove
14、reign Distress in EMs _ 19 Figure 7.Additional Robustness Analysis on the Effect of Safety Net on Banks Returns _ 20 Figure 8.Banks Risk-Taking and Moral Hazard during Sovereign Distress _ 211 Figure 9.Sovereign Downgrades and Bound vs.Unbound Firms in Emerging Markets _ 23 Figure 10.Sovereign Downg
15、rades Impact on Bound vs.Unbound Firms in EMs _ 24 Figure A.II.1 The Impact of a Tightening of Global Financial Conditions on Sovereign and Bank _ 49 Figure A.III.1 Moral Suasion and Risk Shifting:Threshold Effects _ 512 TABLES Table 1.Exposure Channel:The Effect of Sovereign Distress on Bank Equity
16、 at Different Distress Thresholds 290 Table 2.Exposure Channel:Valuation Effect on Fiscal Debt and Key Bank Outcome Variables _ 31 Table 3.Exposure Channel:The effect of debt rollover risks on key bank outcome variables _ 312 Table 4.Safety Net Channel:The Effect on Banks Equity Abnormal Returns _ 3
17、23 Table 5:Safety Net Channel:The Effect on Banks Risk-Taking Activity_ 345 Table 6.Macroeconomic Channel:Baseline Regressions.Change in investment ratio and debt _ 356 IMF WORKING PAPERS The Sovereign-Bank Nexus in Emerging Markets in the Wake of the COVID-19 Pandemic INTERNATIONAL MONETARY FUND 3
18、Table 7.Macroeconomic Channel:Corporate Investment Following a Sovereign Downgrade at_ 367 Table 8.Macroeconomic Channel:Placebo Tests Baseline Regressions _ 38 Table 9:Macroeconomic Channel:Indirect Impact of Sovereign Downgrade on Banks through Firms_ 3938 Table A.I.1 List of Countries in the Emer
19、ging Markets Sample _ 401 Table A.I.2.Sovereign Stress/Default Episodes Coverage _ 412 Table A.I.3.Data Description and Sources _ 423 Table A.I.4 Summary Statistics _ 445 Table A.II.1.Number of daily changes in volatility regimes _ 47 Table A.III.1.Regression Results for the Drivers of Banks Soverei
20、gn Debt Holdings _ 501 ANNEXES Annex I.Data Description and Summary Statistics _ 390 Annex II.Structural Model Estimation and Model Extensions _ 456 Annex III.Examining the Presence of Moral Suasion and Risk-Shifting _ 489 IMF WORKING PAPERS The Sovereign-Bank Nexus in Emerging Markets in the Wake o
21、f the COVID-19 Pandemic INTERNATIONAL MONETARY FUND 4 I.Introduction Public debt in emerging market economies has surged in the wake of the COVID-19 pandemic as economic activity has declined and governments have increased fiscal support to nonfinancial firms and households to cushion the impact of
22、the crisis.Most of the additional government financing needs have been met by domestic banksand their exposure to domestic sovereign debt has reached historic highswhich has reinforced the two-way relationship between the financial health of the sovereign and banking sectors.In this paper,we examine
23、 the empirical strength of this relationship and the channels through which the sovereign and banking sectors interact.The interconnectedness of banks and sovereigns is often referred to as the sovereign-bank“nexus”,whereby shocks originating in one of the two sectors may cause a negative“feedback l
24、oop”and amplify the effect of the shock.Earlier literature has identified three main channels through which shocks from one sector may transmit to the other:the exposure of banks to the sovereign debt through their government debt holdings(the“exposure”channel);the implicit and explicit guarantees o
25、f the sovereign to banks(the“safety net”channel);and the indirect connection between the two sectors through non-financial firms(the“macroeconomic”channel).In the face of an adverse sectoral shock,these channels tend to interact and amplify vulnerabilities,generating an adverse feedback loop(Farhi a
26、nd Tirole 2018;DellAriccia et al.2018).While the linkages between sovereign and banking sector risk have been well explored for advanced economies in previous studies(for example,Acharya et al.2018;Gennaioli,Martin and Rossi,2018),their findings may not be directly generalizable to emerging markets,
27、which tend to have different structural characteristicssuch as a lower level of financial sector development,a larger share of foreign-currency-denominated public debt and higher refinancing risks.These factors could render them more sensitive to external shocks and strengthen the interconnectedness
28、 between the sovereign and banking sectors.Furthermore,the relationship between sovereigns and banks has also become more complex during the pandemic,as interdependencies with the real sector have deepened.Governments have generally supported firms through unprecedented policy measures.In turn,the c
29、orporate sector has become highly dependent on the continuation of policy support in cases where the economic recovery has yet to firmly take hold and corporate vulnerabilities are high,thereby increasing potential spillovers across corporates,banks and sovereign.Against this background,this paper u
30、ses country-level,bank-level,and firm-level data to provide both an overall analysis of the cross-sectoral propagation of sovereign,bank and corporate default risk,and specific analyses of three main channels through which sovereigns and banks can affect each others financial health.Our overall samp
31、le comprises 54 countries and covers the period 1990-2021.The overall shock propagation analysis relies on estimating simultaneous equations at the country level.We exploit the heteroskedasticity in the data to identify structural shocks to the endogenous variables,following Rigobon(2003).This ident
32、ification strategy exploits the fact that changes in the volatility of the structural shocks contain additional information on the relationship between endogenous variables.1 We find that there are significant feedback effects within the nexus in emerging markets and that the strength of the links v
33、aries 1 For example,in a period of large bank risk shocks,we learn more about the response of sovereign risk to bank risk as the covariance between both risks increases.During these periods,bank risk shocks are more likely to occur and can be used as a“probabilistic instrument”to trace the response
34、of sovereign risk.IMF WORKING PAPERS The Sovereign-Bank Nexus in Emerging Markets in the Wake of the COVID-19 Pandemic INTERNATIONAL MONETARY FUND 5 between different sectors.Notably,spillovers from sovereign default risk to banks are,on average,larger than those in the opposite direction from banks
35、 to sovereign default risk.To analyze the exposure channel,we identify the effect of sovereign distress on banks performance by exploiting fiscal shocks and cross-sectional variation in banks holdings of government debt.Fiscal shocks are defined as periods in which the credit default swap spread is
36、above a certain threshold,or a sovereign is in outright default.We find that,in the event of sovereign distress,banks with a 10-percentage-point higher ratio of government debt holdings to total bank assets face an expected default frequency(EDF),that is,0.4 percentage points higher than the average
37、 bank.The difference is economically significant considering that it corresponds to about one-third of median banks EDF.Notably,we also find this effect is almost twice as large for banks with relatively less capital and increases with the level of sovereign distress,thereby curtailing banks capital
38、 and lending significantly in severe sovereign distress episodes.These results are robust to a range of sensitivity checks,including alternative identification strategies to construct fiscal shocks.To examine the relevance of the safety net channel,we focus on the impact of implicit government guara
39、ntees(proxied by the Fitch government support rating)on bank equity returns.We find that such guarantees mitigate banking sector tail risks in the first few months following a fiscal shock by improving banks market returns.However,this effect turns negative after six months,suggesting that the perce
40、ption of a weaker ability to support banks following sovereign distress could undermine investor confidence.Notably,banks with higher implicit guarantees and lower capital expand their loan portfolios relatively more aggressively after sovereign distress,leading to a cumulative credit growth of abou
41、t 8 percentage points higher than other banks and to a larger increase in nonperforming loans.These results suggest that higher government guarantees could increase banks risk-taking behavior after sovereign distress.Finally,in our analysis of the macroeconomic channel,we show that sovereign distres
42、s may also pose risks to non-financial firms,with adverse effects on bank asset quality.Following Almeida et al.(2016),to identify the impact of sovereign downgrades on firm behavior,we exploit the variation across firms as a consequence of the sovereign ceiling policies that rating agencies typical
43、ly apply.These policies require that firms ratings remain at or below the sovereign rating of their country of domicile(i.e.,the sovereign ceiling).The findings show that the sovereign ceiling leads to an asymmetric change in corporate ratings and firm investment following a sovereign downgrade.For
44、instance,firm capital expenditure(as a percent of fixed assets)decreases on average by about 10 percent two years after a sovereign downgrade,and the effect is more pronounced for firms subject to sovereign ceiling policies.In addition,we find that banks loan portfolio quality worsens more in countr
45、ies where such firms are more prevalent.Overall,these findings have important policy implications,including for the treatment of sovereign debt holdings in banking regulation and supervision.The remainder of the paper is organized as follows.Section II presents the conceptual framework underlying ou
46、r empirical analysis.Section III presents some stylized facts on the strength of the nexus in emerging markets before and after the COVID-19 pandemic crisis.Section IV gauges the causal relationship across sovereign,bank and corporate default risks.Section V provides empirical evidence on the key tr
47、ansmission channels.Section VI concludes.II.Conceptual Framework The sovereign and banking sectors are connected through three key channels that facilitate the transmission of shocks from one sector to the other:the exposure channel,the safety net channel,and the macroeconomic IMF WORKING PAPERS The
48、 Sovereign-Bank Nexus in Emerging Markets in the Wake of the COVID-19 Pandemic INTERNATIONAL MONETARY FUND 6 channel.These channels tend to interact with each other and can magnify vulnerabilities in each sector,generating adverse feedback loops(Figure 1).2 The exposure channel stems from the direct
49、 exposure of banks to sovereign risk through their holdings of government debt.A rise in sovereign spreads could reduce the market value of government debt that banks hold and use as collateral to secure financing.As a result,higher bank exposure to sovereign debt has been shown to be a strong predi
50、ctor of a future credit crunch as sovereign distress or default can tighten banks capital constraint and impair their loan supply(Acharya et al.,2018;Bouis,2019;Popov and Van Horen,2015;Feyen and Zuccardi,2019;Gennaioli,Martin,and Rossi,2018).Banks can also reduce private credit in the attempt to in