Banks, government bonds, and default: What do the data say?

Empirical analysis of holdings of sovereign bonds by 20,000 banks in 191 countries and 20 sovereign default episodes over 1998-2012 shows 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 a default year, the average bank’s exposure to bonds correlates with a 7-percentage-point lower growth rate of loans relative to banks without bonds. 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.