Banks, government Bonds, and Default: What do the data Say?

This paper analyzes sovereign bondholdings by 20,000 banks in 191 countries and 20 sovereign default episodes over 1998-2012, establishing two robust facts. First, banks hold many government bonds (on average 9% of assets) in normal times, particularly banks making fewer loans and operating in less financially-developed countries. Second, during default years, banks with the average exposure to government bonds exhibit a lower growth rate of loans than banks without bonds (7-percentage points lower). These results indicate that the “dangerous embrace” between banks and their government plays a key role during sovereign defaults and its strength depends on local conditions.