Sovereign risk and the bank lending channel in Europe

• Published in: Journal of international money and finance 2014-10, Vol.47, p.1-20
• Main Authors: Cantero-Saiz, Maria, Sanfilippo-Azofra, Sergio, Torre-Olmo, Begoña, López-Gutiérrez, Carlos
• Format: Article
• Language: English
• Subjects: Bank lending channel; Banking; Banking industry; Banks; Budget control; Eastern Europe; Eurozone; Loans; Monetary policy; Monetary systems; Risk assessment; Risk management; Sovereign debt; Sovereign risk; Studies; Supply; Western Europe
• ISSN: 0261-5606; 1873-0639
• DOI: 10.1016/j.jimonfin.2014.04.008

The main purpose of this article is to analyze how sovereign risk influences the loan supply reaction of banks to monetary policy through the bank lending channel. Additionally, we aim to test whether this reaction differs in easy and tight monetary regimes. Using a sample of 3125 banks from the euro zone between 1999 and 2012, we find that sovereign risk plays an important role in determining loan supply from banks during tight monetary regimes. Banks in higher sovereign risk countries reduce lending more during tight regimes. However, we find little evidence to support any relationship between sovereign risk and loan supply reaction to monetary policy expansions. These results are very interesting for the way monetary policy is conducted in Europe. Banking union, banking system strength, and the budget control of governments would be necessary measures to reduce the heterogeneous transmission of the monetary policy in the euro zone. •We use a sample of 3125 banks from the European Union between 1999 and 2012.•We quantify the effects of sovereign risk on the bank lending channel.•We test whether these effects differs in easy and tight monetary regimes.•Banks in high sovereign risk countries cut credit more in a tight monetary policy.•Little support for a relationship between sovereign risk and credit in easy policies.