Sovereign Portfolio Composition and Bank Risk

This paper presents evidence on the likely composition effects of sovereign portfolios on two accounting based measures of banks’ ex-post risk profile, using granular data by the European Banking Authority. Our study period covers from 2009 to 2018. We find that banks located in European countries with high sovereign credit risk have riskier balance sheets. Also, banks holding a higher proportion of securities issued by a crisis sovereign are riskier than those with lower exposure to those countries. Whereas holding of government securities of the country where the bank is incorporated does not by itself increase ex-post bank risk, banks are riskier when they hold a higher proportion of these securities and the bank is domicile in a high credit risk sovereign country. Finally, banks that received government capital injections show higher risk profile than those banks that did not receive capital support. Our results lend support to central bank interventions to limit the increase in sovereign risk and limit the negative bank sovereign-bank feedback loop.