Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/225322 
Year of Publication: 
2020
Series/Report no.: 
Deutsche Bundesbank Discussion Paper No. 54/2020
Publisher: 
Deutsche Bundesbank, Frankfurt a. M.
Abstract: 
We develop a model of bank risk-taking with strategic sovereign default risk. Domestic banks invest in real projects and purchase government bonds. While an increase in bond purchases crowds out profitable investments, it improves the government's incentives to repay and therefore lowers its borrowing costs. For low levels of government debt, banks influence their default risks through purchases of bonds. But, for high debt levels, this influence is lost since bank and government default are perfectly correlated. Banks fail to account for how their bond purchases influence the government's default incentives. This leads to socially inefficient levels of bond holdings.
Subjects: 
sovereign debt
financial intermediation
financial repression
bank fragility
JEL: 
G01
G21
G28
ISBN: 
978-3-95729-778-5
Document Type: 
Working Paper

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