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A Research On European Banking Regulations And Their Treatment Of Sovereign Debt

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The following paper attempts to address the need for future research as mentioned in part A. European Banks are not required to hold a capital buffer against the sovereign debt holding of any European state, regardless of the risk involved. As a result European governments had issued excessive debt, taking advantage of a sovereign subsidy of other EU member states in the form of the 0-risk-weight for their MFI. If such a risk finally materialises, MFI will be left undercapitalised because they do not hold a capital buffer for their sovereign exposure. Therefore 0 risk represents a channel, through which sovereign risk can extend to any EU member state. Thus, the focus of the paper is to develop a new measure that quantifies the banks’ risk…show more content…
To support Korte and Steffen’s empirical analysis there are Bolton and Jeanne (2011), who argue how financial integration may lead to ex post contagion and oversupply of “risky” sovereign debt. Further, Acharya et al. (2014) develop a model, which sees banks overleveraged because they invest too much in low risk-weighted instead of diversifying the risk. Korte and Steffen build on this model to develop their hypothesis for the research paper. Korte and Steffen incorporate two streams of literature, which are important to give evidence on how risk weight regulation impairs financial stability in the Eurozone. The first stream focuses on both determinants and interdependence of sovereign risk. These are Duffie et al. (2003); Bolton and Jeanne (2011); Barth et al. (2012); Acharya, Drechsler, and Schnabl (2014). Examples are: • Ang and Longstaff (2013), evaluates the co-movement of sovereign default risk. • Chen (2013), finds that financial linkages likely provide a channel for sovereign risk spillovers. • Kallestrup et al (2013), evaluates how banking sector variables, such as cross-border exposure amplify the effect, that non-domestic sovereign has on domestic sovereign risk. The second stream of literature, evaluates the
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