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The single supervision mechanism and contagion between bank and sovereign risk

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Abstract

The objective of this article is to analyse how the Single Supervision Mechanism (SSM), the first pillar of the European Banking Union, affects contagion between bank and sovereign risk in the eurozone. Additionally, we test whether this contagion is transmitted from banks to sovereigns or vice versa, and how this transmission differs before and after the SSM. On the one hand, using quarterly data from 80 banks and 13 eurozone countries over the period 2009–2016 (2441 observations), we do not find solid evidence that the SSM reduces contagion from sovereign risk to banks’ stock returns. On the other hand, the analysis of credit default swap (CDS) spreads comprises quarterly data from 25 banks and 10 eurozone countries between 2009 and 2016 (771 observations). We find that the announcement of the SSM in March 2013 reduces contagion between bank and sovereign CDS spreads. Additionally, before the announcement of the SSM, an increase in sovereign risk does not alter contagion. However, after this announcement, an increase in sovereign risk leads to lower contagion. Therefore, the announcement of the SSM has an immediate effect on CDS spreads, while there is not enough evidence for banks’ stock returns.

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Fig. 1

Source own elaboration based on data from Datastream

Fig. 2

Source own elaboration based on data from Datastream

Fig. 3

Source own elaboration based on data from Datastream

Fig. 4

Source own elaboration based on data from Datastream

Fig. 5

Source own elaboration based on data from Datastream

Fig. 6

Source own elaboration based on data from Datastream

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Notes

  1. Banks usually hold domestic government debt, which enables them to hold less regulatory capital against that debt. This is because government securities have always been considered risk free (Barth et al. 2012).

  2. These ECB non-conventional measures comprise the following key elements: fixed-rate full allotment for all refinancing operations, liquidity injections and longer-term credit operations, extension of collateral eligibility, currency swap agreements or several purchase programmes, such as the Covered Bond Purchase Programme (CBPP), the Asset-backed Securities Purchase Programme (ABSPP) and the Public Sector Purchase Programme (PSPP).

  3. The second pillar, the SRM, became fully operational on 1 January 2016, and its purpose is to ensure an orderly resolution of failing banks through a common resolution fund financed by the banking sector. The third pillar, the common DGS, is a system in each eurozone country that reimburses depositors (up to a defined limit) if their bank fails and deposits become unavailable. Member banks pay contributions to this guarantee scheme based on their risk profiles and other factors. In addition, the common DGS will improve the information that depositors receive and will reduce the time period to reimburse depositors up to seven working days by 2024.

  4. The ECB started supervising the 126 significant banks of the participating countries, which hold almost 82% of banking assets in the eurozone. The ECB can decide at any time to classify a bank as significant to ensure that high supervisory standards are applied consistently.

  5. CDS contracts are bilateral swap agreements mainly transacted in over-the-counter (OTC) derivative markets and allow the CDS seller to provide protection for the buyer. The spreads represent the regular payments that must be paid by the buyer to the seller for the contingent claim in the case of a credit event.

  6. Austria, Belgium, Finland, France, Germany, Greece, Ireland, Italy, Lithuania, the Netherlands, Portugal, Slovakia and Spain.

  7. We thank an anonymous referee for suggesting this methodology to us.

  8. Following the suggestion of an anonymous referee, we have repeated all the analyses by excluding all insignificant explanatory variables and the results are similar to those reported in this article. These results are not shown, but are available on request.

  9. We thank an anonymous referee for this suggestion.

  10. As regards the control variables in Table 6, only RHML,t (distress risk) is significant with a positive sign in all the models.

  11. De Bruyckere et al. (2013) also had a similar sample size for Eurozone banks in an analysis of contagion between bank and sovereign CDS spreads.

  12. Austria, Belgium, France, Germany, Greece, Ireland, Italy, the Netherlands, Portugal and Spain.

  13. All state variables come from Datastream and are transformed into arithmetic returns, except for the variable Term, which is included in first differences (De Bruyckere et al. 2013).

  14. Following the suggestion of an anonymous referee, we clustered the standard errors of the regressions by year and country.

  15. We calculate excess correlations on a quarterly basis using daily CDS data, because quarterly frequency is the highest frequency for which there is bank balance sheet data available in Datastream (De Bruyckere et al. 2013).

  16. Quarterly bank and sovereign CDS are calculated as the average of the daily CDS of each quarter. Demirgüç-Kunt and Huizinga (2013) followed a similar approach to compute annual CDS from daily data.

  17. Control variables are standardized by calculating the deviation from the average and dividing this by the standard deviation of the variable. Bank-specific variables are standardized at the bank level, while macroeconomic variables are standardized at the country level.

  18. We do not include country dummies in our model, since some countries of the sample contain only one bank, and hence the country dummies in this case could be biased by the situation of the specific bank instead of representing the global situation of the country. Instead, we use macroeconomic variables to control for the situation of the country, such as the GDP growth (ΔGDP), the public debt ratio (PUBDEBT) and the fiscal balance (FISCBAL).

  19. Following the suggestion of an anonymous referee, we have repeated the previous analyses by excluding all insignificant explanatory variables and the results are similar. These results are not reported, but are available on request.

  20. This database does not contain quarterly information about resident banks’ sovereign debt holdings either for Austria and Belgium throughout the whole sample period or for Germany from Q3-2015. So, the robustness checks comprise 22 banks and eight countries (671 observations).

  21. These results are not shown in the article but are available on request.

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This work was supported by University of Cantabria Foundation for Education and Research in the Financial Sector (UCEIF Foundation).

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Correspondence to María Cantero Sáiz.

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Cantero Sáiz, M., Sanfilippo Azofra, S. & Torre Olmo, B. The single supervision mechanism and contagion between bank and sovereign risk. J Regul Econ 55, 67–106 (2019). https://doi.org/10.1007/s11149-018-09373-6

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