DP13709 Risky Bank Guarantees

Author(s): Taneli Makinen, Lucio Sarno, Gabriele Zinna
Publication Date: May 2019
Date Revised: May 2019
Keyword(s): banks, government guarantee, Risk premium, sovereign risk
JEL(s): G23
Programme Areas: Financial Economics, International Macroeconomics and Finance
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=13709

Applying standard portfolio-sort techniques to bank asset returns for 15 countries from 2004 to 2018, we uncover a risk premium associated with implicit government guarantees. This risk premium is intimately tied to sovereign risk, suggesting that guaranteed banks, defined as those of particular importance to the national economy, inherit the risk of the guarantor. Indeed, this premium does not exist in safe-haven countries. We rationalize these findings with a model in which implicit government guarantees are risky in the sense that they provide protection that depends on the aggregate state of the economy.