WORKING PAPER NO. 410 Bank Exposures and Sovereign Stress Transmission

The domestic sovereign exposures have amplified the transmission of sovereign stress to the solvency risk of banks and to their lending activity, both during and after the Euro debt crisis. We estimate the magnitude of this amplification mechanism relying on novel ECB monthly data on sovereign exposures and lending policies of 245 euro-area banks from 2007 to 2015. For the median bank in stressed countries, the amplification due to sovereign exposures almost doubled the response of the bank’s CDS premium to the sovereign CDS premium, and the response of its loan rate to the sovereign yield. Moreover, the losses on domestic sovereign holdings associated with a 1-standard-deviation rise of the 10-year sovereign yield account for 9 % of the actual drop in total loans in stressed countries. No such amplification effects are detected in non-stressed countries. Finally, both yield-seeking and moral suasion motives appear to have affected banks ’ portfolio choices in stressed countries: in response to higher domestic sovereign yields, banks increased their domestic sovereign holdings more if public