IGTA Journal - Winter 2020/2021

29/01/2021 The sovereign-bank-corporate nexus – virtuous or vicious? https://www.ecb.europa.eu/press/key/date/2021/html/ecb.sp210128~8f5dc86601.en.html 13/13 The ECB, for its part, has committed to preserve favourable financing conditions for as long as necessary, reinforcing the fiscal response. The complementarity of fiscal and monetary policy has been instrumental in effectively countering the pandemic crisis. When the health crisis has been successfully overcome and authorities start to phase out the relief measures, this complementarity should remain an important consideration. Thank you for your attention. [1] I would like to thank Sandor Gardo and Benjamin Hartung for their contributions to this speech. [2] The financial stability risks associated with a tightening nexus between sovereigns, banks and corporates in the wake of the COVID-19 pandemic are analysed in the ECB’s latest Financial Stability Review (November 2020). A related framework is also briefly discussed in the IMF’s Global Financial Stability Report (October 2013). [3] There is a rich literature on the impact of the sovereign-bank nexus on financial stability and economic growth, including: Acharya, V., Drechsler, I. and Schnabl, P. (2014), “A Pyrrhic Victory? Bank Bailouts and Sovereign Credit Risk”, Journal of Finance , Vol. 69, No. 6, pp. 2689–2739; Altavilla, C., Pagano, M. and Simonelli, S. (2016), “Bank exposures and sovereign stress transmission”, ECB Working Paper No. 1969; Becker, B., and Ivashina, V. (2018), “Financial Repression in the European Sovereign Debt Crisis”, Review of Finance , Vol. 22, No. 1, pp. 83–115; Bocola, L. (2016), “The Pass-Through of Sovereign Risk”, Journal of Political Economy , Vol. 124, No. 4, pp. 879–926; Bolton, P., and Jeanne, O. (2011), “Sovereign Default Risk and Bank Fragility in Financially Integrated Economies”, IMF Economic Review, Vol. 59, No. 2, pp. 162–94; Farhi, E. and Tirole, J. (2014), “Deadly Embrace: Sovereign and Financial Balance Sheets Doom Loops”, Working Paper 164191, Harvard University; Gennaioli, N., Martin, A. and Rossi, S. (2014), "Banks, Government Bonds, and Default: What Do the Data Say?”, IMF Working Paper 14/120, International Monetary Fund; Popov, A., and van Horen, N. (2015), “Exporting Sovereign Stress: Evidence from Syndicated Bank Lending during the Euro Area Sovereign Debt Crisis”, Review of Finance , Vol. 19, No. 5, pp. 1825–66. [4] The real economy link between sovereigns and corporates and the role of corporate debt have been documented for both the euro area and emerging economies. See, for example: Arellano, C., Bai, Y. and Bocola, L. (2020), “Sovereign Default Risk and Firm Heterogeneity”, NBER Working Paper No. 23314; Du, W. and Schreger, J. (2017), “Sovereign Risk, Currency Risk, and Corporate Balance Sheets”, Columbia Business School; Kwak, J.H (2021), “Corporate-Sovereign Debt Nexus and Externalities”, mimeo, University of Maryland; Wu, S.P.Y. (2020), “Corporate Balance Sheets and Sovereign Risk Premia”, mimeo, University of Wisconsin- Madison. [5] The results of the latest ECB Bank Lending Survey (Q4 2020) were published on 19 January 2021. [6] For a comprehensive summary of the financial market turmoil during the 2007-2008 financial crisis, see: Brunnermeier, M. K. (2009), “Deciphering the Liquidity and Credit Crunch 2007-2008”, Journal of Economic Perspectives , Vol. 23, No. 1, pp. 77–100. [7] For a detailed analysis of the sovereign-bank nexus in the euro area during the COVID-19 pandemic, see also: Guerrero, S. L., J. Metzler, and A. D. Scopelliti (2020), “Developments in the sovereign-bank nexus in the euro area: the role of direct sovereign exposures”, ECB Financial Stability Review (Box 4), November. [8] A similar link between sovereign and corporate bond yields has also been documented in the literature, see for example: Bedendo, M. and Colla, P. (2015), “Sovereign and corporate credit risk: Evidence from the Eurozone”, Journal of Corporate Finance , Vol. 33, pp. 34–52; Bevilaqua, J., Hale, G. and Tallman, E. (2020), “Corporate yields and sovereign yields”, Journal of International Economics ; Eichengreen, B. and A. Mody (2000), “What explains changing spreads on emerging market debt? Capital Flows and the Emerging Economies: Theory, Evidence, and Controversies”, University of Chicago Press. [9] At the same time, public support measures should become increasingly targeted in order to avoid corporate “zombification” via the misallocation of capital or postponed loss recognition. For further details see Laeven, L., Schepens, G. and Schnabel, I. (2020), “Zombification in Europe in times of pandemic”, VoxEU, 11 October. IGTA eJournal | Winter 2020/21 | 18