Discussion Paper Details

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Title: Sovereign Default Risk and Banks in a Monetary Union

Author(s): Harald Uhlig

Publication Date: August 2013

Keyword(s): bank regulation, common central bank, ECB, Euro zone crisis, European Central Bank, haircuts, repurchase operations, risk shifting and sovereign default risk

Programme Area(s): International Macroeconomics

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.

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Bibliographic Reference

Uhlig, H. 2013. 'Sovereign Default Risk and Banks in a Monetary Union'. London, Centre for Economic Policy Research.