Balteanu & Erce: Bank Crises and Sovereign Defaults in Emerging Markets – Exploring the Links

ABSTRACT:

This paper provides a set of stylized facts on the mechanisms through which banking and sovereign distress feed into each other, using a large sample of emerging economies over three decades. We first define “twin crises” as events where banking crises and sovereign defaults combine, and further distinguish between those banking crises that end up in sovereign debt crises, and vice-versa. We then assess what differentiates “single” episodes from “twin” ones. Using an event analysis methodology, we study the behavior around crises of variables describing the balance sheet interconnection between the banking and public sectors, the characteristics of the banking sector, the state of public finances, and the macroeconomic context. We find that there are systematic differences between single” and “twin” crises across all these dimensions. Additionally, we find that “twin” crises are heterogeneous events: taking into account the proper time sequence of crises that compose “twin” episodes is important for understanding their drivers, transmission channels and economic consequences. Our results shed light on the mechanisms surrounding feedback loops of sovereign and banking stress.

 

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