Working Paper: NBER ID: w19343
Authors: Harald Uhlig
Abstract: This paper seeks to understand the interplay between banks, bank regulation, sovereign default risk and central bank guarantees in a monetary union. I assume that banks can use sovereign bonds for repurchase agreements with a common central bank, and that their sovereign partially backs up any losses, should the banks not be able to repurchase the bonds. I argue that regulators in risky countries have an incentive to allow their banks to hold home risky bonds and risk defaults, while regulators in other "safe" countries will impose tighter regulation. As a result, governments in risky countries get to borrow more cheaply, effectively shifting the risk of some of the potential sovereign default losses on the common central bank.
Keywords: No keywords provided
JEL Codes: E51; E58; E61; E65; G21; G28; H63
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Regulatory environment (G38) | Banks' investment strategies (G21) |
| Banks' investment strategies (G21) | Stability of the banks (G21) |
| Regulatory environment (G38) | Likelihood of defaults (G33) |
| Regulators incentivize banks to hold home risky bonds (G28) | Likelihood of defaults (G33) |
| Regulators incentivize banks to hold home risky bonds (G28) | Shift of potential losses to common central bank (F65) |
| Tighter regulations in safe countries (F55) | Less likely to hold risky sovereign bonds (F34) |
| Risk of default shared with central bank (G21) | Governments in risky countries can borrow at lower rates (F34) |