This figure shows the share of sovereign debt owned by domestic banks and the 5-year USD denominated sovereign CDS spread for Italy, Spain, and Portugal. The figure documents that the share of total government debt held by domestic banks increased as the sovereign creditworthiness deteriorated from 2009 to 2012.
This figure shows holdings of domestic government bonds by domestic banks and domestic banks' credit to the nonfinancial corporations and households for Italy, Spain, and Portugal. The figure documents that banks increased their holdings of domestic government bonds and reduced their loans to firms and households from 2009 to 2012.
This figure illustrates the timeline of the economy. There are two dates: t=0 and t=1. Banks have a balance sheet of fixed size of 1 and initial private debt L. At t=0, banks make their investment decisions and the government issues public debt D and announces the tax rate . Between t=0 and t=1, a shock hits the economy. At t=1, the economy can be in the good state with probability and in the bad state with probability 1-. In the good state, the government collects taxes on the high payoff of the private lending technology. In bad state, the government collects taxes on the low payoff of the private lending technology. In both states, tax collection is hit by a sovereign shock y and then used to repay bondholders.
The left panel illustrates the investment opportunity set of banks in a generic country i. They can invest, at t=0, in the (domestic) lending technology, domestic government bonds, and foreign government bonds. The right panel shows the payoff from investing in the lending technology and in domestic government bonds, following the realization of the payoffs from the lending technology at t=1. The right panel shows that the realized payoff from the lending technology is split between banks (after-tax revenues) and the government (tax collection). This uncertain tax collection
This figure shows the payoffs of well capitalized and undercapitalized banks. The left panel shows the payoffs of well capitalized banks and the right panel shows the payoffs of undercapitalized banks. If well capitalized, banks obtain the full payoff in the good state and the post-haircut payoff in the bad state. If undercapitalized, banks obtain the full payoff in the good state and zero in the bad state. The payoff from investing in foreign bonds depends only on the foreign state.
This figure illustrates two equilibria taken from the continuum of equilibria in the WW case. The left panel shows a high home bias equilibrium where both financial sectors allocate the largest share of their government bond portfolio domestically. The right panel shows a low home bias equilibrium, where both governments face sizable foreign demand for their bonds.
This figure shows how the initial bank debt L delimits four cases in the economy: UU, UW, WU, and WW. The left panel shows the two areas W and U for a generic country i. The right panel combines the level of bank debt L in country A on the x-axis and country B on the y-axis and maps the initial debt levels to the four cases in the economy: UU, UW, WU, and WW.
This figure describes the economy when banks also have access to foreign private lending technology. The left panel illustrates the investment opportunities of the financial sector which can invest in the domestic lending technology, the foreign lending technology, domestic government bonds, and foreign government bonds. The right panel shows the payoffs, after they are realized, at t = 1.
This figure refers to an economy where country A is risky and country B is riskless. The left panel shows the equilibrium in the WW case where the riskless country has higher debt capacity and attracts foreign banks. The right panel shows the equilibrium in the UW case where the undercapitalization of one financial sector generates perfect home bias in the entire economy, with both sovereigns facing only domestic demand for their bonds.
This figure illustrates the two equilibria in the UW case in the low sovereign risk scenario. The left panel shows the perfect home bias equilibrium and the right panel shows the asymmetric equilibrium. The left panel illustrates the standard perfect home bias equilibrium where the binding limited liability induces undercapitalized banks in A to tilt their government bond portfolio domestically. The right panel shows that the economy can fall in an asymmetric equilibrium where country A faces both domestic and foreign demand for its bonds.
This figure illustrates the nine possible arrangements between banks and governments in the economy. In the first arrangement (type a), both banks invest in both government bonds. In the second arrangement (type b), both banks invest only domestically. In the third arrangement (type c), bank A invests in both countries and bank B invests only domestically. In the fourth arrangement (type d), bank B invests in both countries and bank A invests only domestically. In the fifth arrangement (type e), bank A invests only non-domestically and bank B in both countries. In the sixth arrangement (type f), bank B invests only non-domestically and bank A in both countries. In the seventh arrangement (type g), both banks invest only non-domestically. In the eight arrangement (type h), both banks invest only in country B. In the ninth arrangement (type i), both banks invest only in country A. The degenerate arrangements where a bank does not invest in the bond markets are not included.
The top figures show the share of sovereign debt owned by domestic banks and the 5-year USD-denominated sovereign CDS spread for Greece and Ireland. The bottom figures show holdings of domestic government bonds by domestic banks and domestic banks' credit to the non-financial private sector for Greece and Ireland. The top figures document that the share of total government debt held by domestic banks increased as the sovereign creditworthiness deteriorated from 2009 to 2012. The bottom figures document that, during the same period, banks increased their holdings of domestic government bonds and reduced their loans to firms and households.