No. 1397 - The impact of sovereign tensions on bank lending: identifying the channels at work

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by Fabiana SabatiniDecember 2022

This paper assesses the impact of the two main direct channels through which tensions in sovereign bond markets are transmitted to banks’ balance-sheets and to their ability to provide credit. In particular, it disentangles the effect stemming from the worsening in banks’ capitalization (balance sheet channel) from that associated with a reduced ability to raise funds using government bond holdings as collateral (liquidity channel).

The results indicate that, after the sudden rise in yields on Italian government bonds observed in May 2018, the banks with a higher ratio of those bonds to total assets reduced credit supply to firms more, in line with the literature. The work also shows that the more marked credit contraction mainly reflected the negative shock on bank capitalization, while the liquidity channel would not be activated.