Sovereign Stress, Banking Stress, and the Monetary Transmission Mechanism in the Euro Area | Asian Development Bank

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Sovereign Stress, Banking Stress, and the Monetary Transmission Mechanism in the Euro Area

Publication | February 2018
Sovereign Stress, Banking Stress, and the Monetary Transmission Mechanism in the Euro Area

Government bond yield spread (sovereign stress) and the share of nonperforming loans (banking stress) increase firms’ financing costs and have a negative effect on the monetary transmission mechanism.

We investigate to what extent sovereign stress and banking stress have contributed to the increase in the level and in the heterogeneity of nonfinancial firms’ financing costs in the Euro area during the European debt crisis and how both have affected the monetary transmission mechanism. Employing a large firm-level data set containing 2 million observations, we are able to identify the effect of government bond yield spreads (sovereign stress) and the share of non-performing loans (banking stress) on firms' financing costs in a panel model by assuming that idiosyncratic shocks to individual firms are uncorrelated with country-specific variables. We find that the two sources of stress have increased firms’ financing costs controlling for country and firm-specific factors. Moreover, we estimate both to have significantly impaired the monetary transmission mechanism.

WORKING PAPER NO: 811