Linking Bank Crises and Sovereign Defaults: Evidence from Emerging Markets

44 Pages Posted: 24 May 2017

Date Written: February 2017

Abstract

We analyze the mechanisms through which bank and sovereign distress feed into each other, using a large sample of emerging market economies over three decades. After defining “twin crises” as events where bank crises and sovereign defaults combine, and further distinguishing between those bank crises that end up in sovereign defaults and vice-versa, we study what differentiates “single” and “twin” events. Using an event analysis methodology, we document systematic differences between “single” and “twin” crises across various dimensions. We show that many of the regularities often associated with either “bank” or “debt” crises are present in twin events only. We further show that “twin” crises themselves are heterogeneous events: the proper time sequence of crises that compose “twin” episodes is important for understanding these events. Guided by these facts, we use discrete-variable econometric techniques to assess the main channels of distress transmission between crises. We find that balance sheet interconnections, credit dynamics, financial openness and economic growth are important drivers of twin crises. Our results inform the flourishing theoretical literature on the mechanisms surrounding feedback loops of sovereign and bank stress.

Keywords: Banking Crises, Sovereign Defaults, Feedback Loops, Balance Sheets

JEL Classification: E44, F34, G01, H63

Suggested Citation

Balteanu, Irina and Erce, Aitor, Linking Bank Crises and Sovereign Defaults: Evidence from Emerging Markets (February 2017). European Stability Mechanism Working Paper No. 22, Available at SSRN: https://ssrn.com/abstract=2972818 or http://dx.doi.org/10.2139/ssrn.2972818

Irina Balteanu

Banco de España ( email )

Alcala 50
Madrid 28014
Spain

Aitor Erce (Contact Author)

UPNA ( email )

Pamplona
Spain

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