Successfully reported this slideshow.
We use your LinkedIn profile and activity data to personalize ads and to show you more relevant ads. You can change your ad preferences anytime.

Austerity to save the banks

179 views

Published on

Presentation from ADEMU Fiscal Risk and Public Sector Balance Sheets Conference at the University of Bonn, July 6-7

Published in: Economy & Finance
  • Be the first to comment

  • Be the first to like this

Austerity to save the banks

  1. 1. Comments on: Austerity to save banks? A qualitative model of sovereign default with endogenous default costs and a financial sector by Dominik Thaler (Bank of Spain) Florian Buck (German Ministry of Finance) ADEMU Workshop – Bonn, July 6-7, 2017
  2. 2. 2 The paper in a nutshell: why do governments repay sovereign debt? Model of strategic sovereign default • explains output costs AND exclusion • highlights stabilizing effect of home bias [Gennaioli et al., 2014; Engler & Große Steffen, 2016]
  3. 3. 3 Model mechanism: Strategic default in a banking economy (Ricardian) Household Smart Bank Firm Benevolent Government External debt Deposits Loans Loans Deposits Bonds Equity Bonds Bonds Direct lending Financial friction Lump-sum tax less efficient
  4. 4. 4 Model mechanism: trading-off net cost and benefits of default When the government defaults on its debt… • Output costs • Banks' equity drops & leverage constraint becomes binding • Banks provide less credit -> deposit-loan spread increases • Households provide less-efficient direct capital to firms • Lower capital, less production and income for household • External exclusion • Government could raise external debt that would ow into inefficient direct investment -> Foreign debt capacity shrinks • Only when equity has risen again, external lending becomes optimal again
  5. 5. 5 Discussing the key assumption: Superiority of bank orientation due to financial frictions • What would be the first best allocation in the model? • Maximizing intermediated lending • Reason: Inefficiencies arise when banking sector is constrained by leverage ratio • Optimal policy response • What will happen, if bank bailout is allowed? • Empirical discussion of main channel • Prediction: Households provide more direct lending in times of default • Reason: Substitution due to constrained banking
  6. 6. 6 Discussing the role of the government: benevolent, omniscient, but limited? • The toolkit of the government • Lump sum taxes and bonds (to finance fixed expenditures) • Strategic default choice: full repayment or full default ⨻ What will happen with extra capital requ. for bonds? • Discussion: partial default (Sturzenegger&Zettelmeyer, 2008) • Inefficient bond holding restriction ex-ante • Banks would not invest into bonds at all • Reason #1: World interest rate < return on domestic capital • Reason #2: Bonds are risky • Minor: How does austerity cost enter into the model?
  7. 7. 7 Policy application: Is the model mechanism idiosyncratic to Greece? • Paper claims: “Greece seems an ideal match for the model” (p. 26) – Are Italy, Portugal and Spain similar examples? What about calibrating Cyprus? – Are the model predictions consistent with patterns in less developed countries? • Paper argues: “modeling was guided by the European debt crisis“ (p. 27) – Institutional environment in EMU: What will happen, if we introduce the ECB (e.g. provision of ELA-credit) – National banking systems are interconnected -> default costs abroad and feedback effects for sovereign
  8. 8. 8 Bank exposure and sovereign risk: Consistency with correlation of CDS and exposure?
  9. 9. 9 Bank exposure and sovereign risk: Disciplinary device vs. diabolic loop Two competing hypotheses in literature • Sovereign Default View: Bank exposure can act as a disciplinary device for the sovereign. – Prediction: Default risk falls with rising exposure – Key: Adverse effects on domestic bank’s balance sheets – This paper; Gennaioli et al., 2014; Engler and Große Steffen, 2016 • Sovereign-Bank Nexus View: diabolic loop of risk contagion between sovereign and domestic banking sector. – Prediction: Default risk rises with rising exposure – Key: Spillovers from banking sector: credit supply & bailout channel; from sovereign: portfolio, collateral, guarantee and sovereign rating channel – Brunnermeier et al., 2016; Kiyotaki &Moore, 2005; Arezki et al., 2011
  10. 10. 10 Bank exposure and sovereign risk: Main channels responsible for diabolic loop transmission
  11. 11. 11 Bank exposure and sovereign risk: Idea of an empirical exercise The role of state dependency (Podstawski&Velinov, 2016) • Diabolic loop mechanism particularly pronounced during times of financial distress – Destabilizing effect from bank exposure in countries hardest hit by the crisis (SPA, ITA, POR) • Bank exposure stronger disciplinary effect during times of fiscal stress – Stabilizing effect from bank exposure in countries less hit by the crisis (FRA, DEU, NLD)
  12. 12. 12 Conclusion: Austerity to save banks • Sovereign-financial nexus very timely topic in sovereign debt theory/empirics – Author has set up important questions for regulators and policy-makers – Main contribution: endogenising output and exclusion cost – Calibration of empirically plausible magnitudes of the consequences of default for Greek data • Policy Application – Careful discussion: Is banks‘ home bias good or bad for public debt sustainability?

×