Bank Capital Regulation in the Euro Area and the Sovereign-Bank Nexus

Abstract

We examine how banks in the euro area adjust their exposure to domestic government debt in response to changes in macroprudential capital regulation. In particular, we analyze the effects on the banks’ interconnectedness with their sovereign, referred to as the sovereign-bank nexus, which is considered particularly important for financial stability. To this end, we estimate panel vector autoregressive models for euro-area country groups using a measure of macroprudential policy constructed from the Macroprudential Policy Evaluation Database. Our main findings show that banks in peripheral countries increase their holdings of domestic government bonds in response to a restrictive capital-based macroprudential policy shock, suggesting a strengthening of the sovereign-bank nexus. In contrast, in core countries, the reaction is the opposite. We find that differences in capital positions across country groups can explain our results, which are robust to changes in the econometric setup and the macroprudential indicator used.