## _wp1384 - References ## Source details **Canonical URL:** [_wp1384 - References](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2013/_wp1384.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2013/_wp1384.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2013/_wp1384.pdf.json) --- ### I. Introduction and context - Italian 10-year government bond spreads: - Remained below 200 basis points (bps) until June 2011. - Climbed, peaking at over 500 bps at end-2011. - Tightened in spring 2012 after the 3-year Long Term Refinancing Operations (LTRO). - Widened again reaching more than 500 bps in July 2012. - Came down steadily since the announcement of the details of the Outright Monetary Transactions (OMT) program in September 2012. - Bank funding and lending conditions: - Banks’ CDS spreads and bond yields exceeded those of other European peers in summer 2011. - 12-month credit growth to the non-financial private sector dropped from 3.5 percent in November 2011 to -0.9 percent in December 2012. - Paper objectives: - Examine determinants of Italian sovereign spreads movements: role of investor risk appetite, fiscal developments, and news (international and Italian specific). - Assess pass-through of sovereign spreads to Italian banks’ CDS, bond yields, lending rates and credit growth. ### II. Key empirical findings on sovereign spreads drivers - Main drivers identified: - Investor risk appetite proxied by the VIX index (implied volatility of S&P options) has a statistically significant impact on Italian sovereign spreads. - News related to the euro area debt crisis and Italy-specific events have sizable impacts on daily changes in 10-year spreads. - Projected public debt to GDP ratio and the share of public debt securities held by non-residents amplify the effect of risk appetite shocks on spreads. - Specific quantitative relationships and observations: - From end June 2011 to end December 2011, 10-year bond spreads rose from 186 bps to 527 bps. - The monthly standard deviation of spreads peaked in December 2011–January 2012. - Interaction effects: - Changes in the VIX interacted with the projected debt to GDP ratio push up spreads. - The VIX interaction with the share of public debt held by non-residents significantly increases spread sensitivity to risk appetite shocks. - Example from text: - At the debt to GDP ratio projected for 2012, a one standard deviation shock in the VIX index sustained for 5 days (a 10 percentage point increase) would increase spreads by almost 24 bps. - Event-driven volatility: - Largest daily changes in spreads occurred at the time of international and Italian-related announcements and events. - Both international bad/good news and Italy-specific bad/good news have statistically significant and large impacts on daily changes in spreads (regressions over January 1, 2008–October 22, 2012). ### III. Co-movements among banks’ CDS and common factor - Principal component evidence: - Almost 70 percent of the variance in the euro area banks’ CDS and sovereign spreads series is explained by the first principal component. - Loadings on the first principal component are all positive and similar in size, suggesting a latent common risk indicator. - Channels linking sovereign spreads and banks’ risk: - Financial-sector weakness driving sovereign spreads where governments committed large public resources. - Shocks to sovereign bond yields affecting banks via rating caps, funding costs, profitability, and portfolio values. - Risk repricing and changes in investor risk appetite transmitting shocks across bank and sovereign risk premiums. ### IV. Impact of sovereign spreads on banks’ market indicators - Correlation and tracking: - Average CDS spreads of the five largest Italian banks tracked the iTraxx Europe senior financial index and average CDS of largest euro area banks, but exceeded peers in summer 2011 during sovereign stress. - Correlation between changes in banks’ CDS spreads and changes in the 10-year Italian government bond spread over the Bund increased from less than 0.1 (January 2006–June 2007) to 0.6 (July 2001–October [text cuts off]). - Econometric (CDS differential) findings (sample January 1, 2007- July 31, 2012): - Changes in sovereign spreads significantly impact the CDS spreads differential of the five largest Italian banks versus a group of euro area banks. - Interaction sovereign spreads × bank capital: positive and significant — impact larger for institutions with relatively lower capital. - Interaction sovereign spreads × relative NPL ratio: positive and significant — impact larger for banks with higher non-performing loans. - VIX index: statistically significant effect on dynamics of four banks’ CDS. - Libor-OIS spread: tensions in interbank market do not appear to have increased Italian banks’ CDS spreads relative to other euro area banks. ### V. Impact on banks’ bond yields - Econometric (bond yield differential) findings (period January 1, 2007- July 31, 2012): - Changes in sovereign spreads significantly impact the bond yield differential of the five largest Italian banks vis-à-vis a group of euro area banks. - Interaction effects: - Sovereign spread × bank capital: positive and significant for four of the Italian banks. - Sovereign spread × relative NPL ratio: positive and significant. - Interpretation: banks with lower relative capital ratios and higher non-performing loans were more sensitive to changes in sovereign spreads. - Quantified effect: - A 100 bps widening in Italian sovereign spreads would result in an average 15-20 bps increase in Italian banks’ bond yields compared to other euro area banks. - VIX index: positive sign; statistically significant consistently only for two banks. - Libor-OIS spread: mixed evidence on statistical significance for bond yields. ### VI. Transmission to lending conditions and credit volumes - Lending rates and sovereign spreads: - Rates on new firm loans increased by 100 bps in the second part of 2011. - Rates on new mortgages rose by 80 bps in the same period. - From January (unnamed year in source), rates on firm loans started to decline as sovereign spreads fell. - Movements in Italian bank securities’ yields have been more correlated with sovereign spreads than with the 3-month euribor. - VAR (monthly, January 2006-September 2012) pass-through results: - Endogenous variables: lending rate, 10-year government bond spread over the Bund, average CDS spreads of the five largest Italian banks (all in first differences). - Exogenous variable: changes in the 3-months euribor. - Pass-through: - About 30-40 percent of the increase in sovereign spreads is transmitted to firm lending rates within three months. - 50-60 percent is transmitted within six months. - Pass-through is somewhat higher for small loans. - Supporting estimate from literature: - Albertazzi et al. (2012): a temporary 100 bps increase in 10-year government bond spreads is associated with about 50 bps increase in firm loan rates after a quarter; permanent increases fully transmitted after one year. - Credit volumes and composition: - 12-month credit growth to the non-financial private sector dropped from 3.5 percent in November 2011 to -0.9 percent in December 2012. - 12-month growth in loans to small firms declined from 0.4 percent year-on-year in November 2011 to -5.9 per cent in November 2012. - Bank and business surveys at end-2011 point to tight lending standards similar to the period after the Lehman bankruptcy. - Supply vs. demand (quarterly, 2003Q2-2012Q3): - At end-2011, supply constraints driven by bank funding difficulties prevailed over weak demand: - Estimates of excess demand suggest growth in loan demand exceeded credit supply by 0.5 percentage points in 2011Q4. - Net corporate bond issuance returned positive in 2011Q4 after being negative for several months, suggesting substitution from bank borrowing to bond issuance. - In 2012, weak demand drove changes in credit more than supply. - After LTROs and other policy actions, estimated demand for credit fell well short of supply. - Historical perspective: - Four quarters since the start of the recession, nominal annual credit growth to the private sector declined by 5.4 percentage points, compared to declines of 13.2 and 11.0 percentage points respectively during corresponding periods in the early 1990s and 2008–09. ### VII. Main conclusions - Volatility in the Italian sovereign debt market intensified since the summer of 2011, pushing up Italian banks’ funding costs and tightening lending conditions. - Shocks in investor risk appetite, euro area debt crisis news, and Italy-specific news have been important drivers of Italian sovereign spreads. - Italy’s high public debt and the large share of non-resident holdings of government debt amplified the impact of investor risk appetite shocks on spreads. - Italian banks’ CDS spreads exceeded those of euro area peers since summer 2011; sovereign spreads significantly contributed to widening this differential. - Banks with lower relative capital ratios and higher non-performing loans are more sensitive to changes in sovereign spreads. - Increases in sovereign spreads rapidly drive up firm lending rates (about 30-40 percent of the shock transmitted within a quarter). - Credit growth to Italian firms declined significantly, reflecting both weak demand and supply constraints; supply constraints prevailed at end-2011, while weak demand dominated in 2012. ### VIII. Policy implications and recommendations - Reduce vulnerabilities to contain sovereign risks: - Need to reduce country-specific vulnerabilities (e.g., high debt levels). - Need to reduce euro area vulnerabilities. - Financial stability considerations: - Large share of non-resident holdings of government debt increases sensitivity of spreads to global risk appetite shocks—implying benefits from measures that enhance investor base stability and reduce rollover/funding risks. - Strengthening bank balance sheets (capital ratios, asset quality) can mitigate the amplification of sovereign stress into bank funding costs and lending conditions. - Broader priorities: - Continued efforts to strengthen banks’ capital buffers and reduce impaired assets, given banks with lower capital and higher NPLs are more sensitive to sovereign shocks. ### IX. Appendix highlights - Appendix 1 — Daily regression (January 1, 2008-October 22, 2012) for changes in 10-year government bond spreads over the Bund (three reported specifications): - Lagged dep. variable: 0.05, 0.05, 0.07 (P-value: 0.04, 0.000, 0.00). - International bad news 2/: 13.16, 12.61, 12.99 (P-value: 0.000, 0.000, 0.00). - International good news 2/: -14.73, -14.36, -12.5 (P-value: 0.000, 0.000, 0.00). - Italy specific bad news 3/: 15.80, 15.74, 15.72 (P-value: 0.000, 0.000, 0.00). - Italy specific good news 3/: -38.37, -38.52, -38.3 (P-value: 0.000, 0.000, 0.00). - D(VIX): 1.96 (P-value: 0.01). - Projected debt * D(VIX): 0.02 (P-value: 0.01). - Share of debt held by foreigners * D(VIX): 0.04 (P-value: 0.01). - Number of observations: 1252, 1252, 1171. - Adjusted R-squared: 0.18, 0.17, 0.17. - Notes: Instruments were lagged changes in the VIX and lagged interaction terms between changes in the VIX and projected debt or the share of public debt securities held by non residents. - Appendix 2 — Selected International/EU events classified as "Bad" or "Good" (selected entries with dates as reported): - International/EU — Bad (selected): - Bear Stearns bailout — March 14, 2008 - Lehman bankruptcy — September 15, 2008 - G-7 meeting fails to address Greek debt problem — February 7, 2010 - EU-IMF program on Greece announced — April 11 2010 - S&P downgrades Greece and Portugal — April 27, 2010 - Portuguese and Irish program events, downgrades and contagion warnings between 2010 and January 23, 2012. - International/EU — Good (selected): - At the G-20 Finance Ministers meeting IMF funding is boosted — March 15, 2009 - 750 billion rescue package is announced — May 10, 2010 - First LTRO — December 21, 2011 - Second LTRO — February 29, 2012 - President Draghi's speech suggesting ECB willingness to buy sovereign bonds in secondary markets — July 26, 2012 - ECB announces Outright Market Transactions program — September 6, 2012 - German Constitutional Court ruling on ESM and Fiscal Pact — September 12, 2012 - Appendix 2 — Italy related events (selected, with dates): - Italy — Bad: - Prime Minister's position weakens — September 11, 2011 - S&P's sovereign rating downgrade — September 19, 2011 - Moody's sovereign rating downgrade — October 4, 2011 - Fitch's sovereign rating downgrade — October 7, 2011 - After Prime Minister's resignation, uncertainty during consultations — November 12, 2011 - S&P's sovereign rating downgrade — January 14, 2012 - Moody's sovereign rating downgrade — February 13, 2012 - Italy — Good: - ECB starts buying Italian government bonds under the SMP program — August 8, 2011 - Italian government approves consolidation package (manovra d'Agosto) — August 12, 2011 - Monti consolidation package is announced — December 5, 2011 - Cabinet approves liberalization decree — January 20, 2012 - Parliament approves liberalization decree — March 24, 2012 - Parliament approves labor market reform — June 27, 2012 - Appendix 3 — Banks included in samples: - Euro area banks: Erste, Raiffesein, KBC, BNP Paribas, Credit Agricole, Societe Generale, Deutsche Bank, Commerzbank, Rabobank, ING group, Santander, Banco Bilbao Vizcaya Argenta. - Italian largest banks: Unicredit, Intesa San Paolo, Monte dei Paschi, Banco Popolare, Unione Banche Italiane. - Appendix 4 — Estimated Credit Demand and Supply (quarterly, 2003Q1-2012Q3): - Lagged dep. Variable: 0.98, 0.86, 0.60, 0.74, 0.60, 0.86 (P-value: 0.000, 0.000, 0.01, 0.000, 0.01, 0.00). - Lending standards 2/: -0.01, -0.01, -0.01 (P-value: 0.01, 0.000, 0.00). - Demand indicator 3/: 0.01, 0.01, 0.01 (P-value: 0.000, 0.000, 0.00). - Lending rate: 0.5, 0.14, 0.50 (P-value: 0.03, 0.45, 0.03). - D(Confidence indicator) 4/: -0.13 (P-value: 0.17). - Adjusted R-squared reported: 0.86, 0.91, 0.87, 0.90, 0.000, 0.87. - Sources: Bank of Italy; and IMF staff estimates. *Source: _wp1384 - References (excerpts from the referenced IMF PDF chapter/section).* ### References ............................................................................................................. ### _wp1384 - References ### I. Introduction and context - Since the summer of 2011, Italian 10-year government bond spreads: - Remained below 200 basis points (bps) until June 2011. - Climbed, peaking at over 500 bps at end-2011. - Tightened in spring 2012 after the 3-year Long Term Refinancing Operations (LTRO). - Widened again reaching more than 500 bps in July 2012. - Came down steadily since the announcement of the details of the Outright Monetary Transactions (OMT) program in September 2012. - Bank funding and lending conditions: - Banks’ CDS spreads and bond yields exceeded those of other European peers in summer 2011. - 12-month credit growth to the non-financial private sector dropped from 3.5 percent in November 2011 to -0.9 percent in December 2012. - Paper objectives: - Examine determinants of Italian sovereign spreads movements: role of investor risk appetite, fiscal developments, and news (international and Italian specific). - Assess pass-through of sovereign spreads to Italian banks’ CDS, bond yields, lending rates and credit growth. ### II. Key empirical findings on sovereign spreads drivers - Main drivers identified: - Investor risk appetite proxied by the VIX index (implied volatility of S&P options) has a statistically significant impact on Italian sovereign spreads. - News related to the euro area debt crisis and Italy-specific events have sizable impacts on daily changes in 10-year spreads. - Projected public debt to GDP ratio and the share of public debt securities held by non-residents amplify the effect of risk appetite shocks on spreads. - Specific quantitative relationships and observations: - From end June 2011 to end December 2011, 10-year bond spreads rose from 186 bps to 527 bps. - The monthly standard deviation of spreads peaked in December 2011–January 2012. - Interaction effects: - Changes in the VIX interacted with the projected debt to GDP ratio push up spreads. - The VIX interaction with the share of public debt held by non-residents significantly increases spread sensitivity to risk appetite shocks. - Example provided in text: - At the debt to GDP ratio projected for 2012, a one standard deviation shock in the VIX index sustained for 5 days (a 10 percentage point increase) would increase spreads by almost 24 bps. - Event-driven volatility: - Largest daily changes in spreads occurred at the time of international and Italian-related announcements and events. - Both international bad/good news and Italy-specific bad/good news have statistically significant and large impacts on daily changes in spreads (regressions over January 1, 2008–October 22, 2012). ### III. Impact of sovereign spreads on banks and lending - Banks’ market indicators: - The average CDS spreads of the five largest Italian banks tracked the iTraxx Europe senior financial index and average CDS of largest euro area banks, but exceeded peers in summer 2011 during sovereign stress. - Correlation between changes in banks’ CDS spreads and changes in the 10-year Italian government bond spread over the Bund increased from less than 0.1 (January 2006–June 2007) to 0.6 (July 2001–October [text cuts off]). - Pass-through to bank funding costs and lending conditions: - Changes in sovereign spreads affect CDS spreads and bond yields differentials of the five largest Italian banks. - The effect is larger for banks with relatively lower capital ratios and higher non-performing loans ratios. - Transmission to corporate borrowing: - About 30-40 percent of the increase in sovereign spreads is transmitted to firm borrowing rates within three months. - 50-60 percent is transmitted within six months. - Drivers of lending slowdown: - Credit supply constraints from bank funding pressures are identified as the main driver of the lending slowdown at the end of last year. ### IV. Policy implications and recommendations - Reduce vulnerabilities to contain sovereign risks: - Need to reduce country-specific vulnerabilities (e.g., high debt levels). - Need to reduce euro area vulnerabilities. - Financial stability considerations: - Large share of non-resident holdings of government debt increases sensitivity of spreads to global risk appetite shocks—implying benefits from measures that enhance investor base stability and reduce rollover/funding risks. - Strengthening bank balance sheets (capital ratios, asset quality) can mitigate the amplification of sovereign stress into bank funding costs and lending conditions. ### V. Organization of the paper (structure) - Section II: analyses drivers of Italian sovereign spreads. - Section III: discusses impact of sovereign spreads on Italian banks’ CDS spreads. - Section IV: discusses impact on banks’ bond yields. - Section V: assesses implications of sovereign spreads movements on lending conditions. - Section VI: concludes. *Source: _wp1384 - References (excerpts from the referenced IMF PDF chapter/section).* ### 2012. Co-movements among banks’ CDS ### 2012. Co-movements among banks’ CDS ### Co-movements and common factor - Peaks in banks’ CDS and sovereign spreads have coincided with major international events, such as the Lehman Brothers’ bankruptcy, and the announcement of the Greek program. - A principal component analysis indicates that almost 70 percent of the variance in the euro area banks’ CDS and sovereign spreads series is explained by the first principal component. - The loadings on the first principal component are all positive and similar in size, suggesting a latent common risk indicator driving movements across series. ### Channels linking sovereign spreads and banks’ risk - Three possible channels for correlation: - Financial-sector weakness driving sovereign spreads, especially where governments committed large public resources to support financial institutions. - Shocks to sovereign bond yields impacting banks’ risk profile via: - Rating agencies capping bank ratings on the basis of sovereign rating. - Government bond yields affecting banks’ funding costs, profitability, and the value of government securities in banks’ portfolios. - A sovereign with heightened risk having limited room to support the banking system if needed. - Risk repricing and changes in investor risk appetite transmitting shocks across both bank and sovereign risk premiums. ### Econometric analysis — CDS spreads differential - Sample and dependent variable: - Daily observations covering the period January 1, 2007- July 31, 2012. - Dependent variable: change in the differential between 5-year CDS spreads of each of the five largest Italian banks and the average CDS spreads of a group of euro area banks. - Explanatory variables included: - Lagged dependent variable. - 5-year Italian sovereign CDS spreads or 10-year government bond spreads over the Bund (lagged). - Bid-ask spreads of each bank’s CDS premium (indicator of CDS liquidity; bid-ask spread is stationary). - VIX index (proxy for general risk aversion). - Euro 3-month Libor-OIS spread (measure of counterparty risk in the interbank market). - Estimation method: - Seemingly unrelated regression to account for error term correlation among the five Italian banks. - All variables are differenced except the bid-ask spread. - Key econometric findings: - Changes in sovereign spreads have had a significant impact on the CDS spreads differential of the five largest Italian banks with respect to a group of euro area banks. - Interaction between sovereign spreads and bank capital: - The interaction term between sovereign spreads and bank capital has a positive and significant coefficient. - Interpretation: the impact of sovereign risk on bank risk is larger for institutions with relatively lower capital levels. - Interaction between sovereign spreads and non-performing loans (NPLs): - The interaction term between sovereign spreads and the relative non-performing loan ratio has a positive and significant coefficient. - Interpretation: sovereign spreads shocks have a greater impact on CDS spreads of banks with higher non-performing loans. - VIX index: - Statistically significant effect on the dynamics of four banks’ CDS, indicating higher credit risk premiums on some Italian banks when risk appetite declines. - Libor-OIS spread: - Tensions in the interbank market, as measured by the Libor-OIS spreads, do not appear to have increased Italian banks’ CDS spreads relative to other euro area banks. ### Econometric analysis — bank bond yields - Sample and dependent variable: - Period January 1, 2007- July 31, 2012. - Dependent variable: change in the differential between yields on bonds issued by Italian banks and the average yields on bonds issued by a group of euro area banks. - Explanatory variables included: - Lagged dependent variable. - Changes in 5-year Italian sovereign CDS spreads or 10-year government bond spreads over the Bund (lagged). - Changes in the VIX index. - Changes in the euro 3-month Libor-OIS spread. - Interaction terms: lagged changes in sovereign spreads interacted with relative bank capital and relative NPL ratio. - Estimation method: - Seemingly unrelated regression. - Key econometric findings: - Changes in sovereign spreads have had a significant impact on the bond yield differential of the five largest Italian banks vis-à-vis a group of euro area banks. - Interaction effects: - Sovereign spread × bank capital: positive and significant coefficient for four of the Italian banks. - Sovereign spread × relative NPL ratio: positive and significant coefficient. - Interpretation: banks with lower relative capital ratios and higher non-performing loans were more sensitive to changes in sovereign spreads. - Quantified effect: - A 100 bps widening in Italian sovereign spreads would result in an average 15-20 bps increase in Italian banks’ bond yields compared to other euro area banks. - VIX index: - Positive sign; statistically significant consistently only for two banks. - Libor-OIS spread: - Mixed evidence on statistical significance for bond yields. ### Impact on lending conditions and credit volumes - Lending rates and sovereign spreads: - Rates on new firm loans increased by 100 bps in the second part of 2011. - Rates on new mortgages rose by 80 bps in the same period. - From January (unnamed year in source), rates on firm loans started to decline as sovereign spreads fell. - Movements in Italian bank securities’ yields have been more correlated with sovereign spreads than with the 3-month euribor. - VAR analysis (monthly, January 2006-September 2012): - Endogenous variables: lending rate, 10-year government bond spread over the Bund, average CDS spreads of the five largest Italian banks (all in first differences). - Exogenous variable: changes in the 3-months euribor. - Pass-through results: - About 30-40 percent of the increase in sovereign spreads is transmitted to firm lending rates within three months. - 50-60 percent is transmitted within six months. - Pass-through is somewhat higher for small loans. - Supporting literature: - Albertazzi et al. (2012): during the sovereign debt crisis, a temporary 100 bps increase in 10-year government bond spreads is associated with about 50 bps increase in firm loan rates after a quarter; permanent increases fully transmitted after one year. - Credit volumes and composition: - 12-month credit growth to the non-financial private sector dropped from 3.5 percent in November 2011 to -0.9 percent in December 2012. - 12-month growth in loans to small firms declined from 0.4 percent year-on-year in November 2011 to -5.9 per cent in November 2012. - Evidence from bank and business surveys at end-2011 points to tight lending standards similar to the period after the Lehman bankruptcy. - Supply vs. demand in credit growth (loan supply and demand functions, sample 2003Q2-2012Q3): - Model uses Bank Lending Survey indicators as proxies for unobserved demand and supply; estimated with instrumental variables. - At end-2011, supply constraints driven by bank funding difficulties prevailed over weak demand: - Estimates of excess demand suggest growth in loan demand exceeded credit supply by 0.5 percentage points in 2011Q4. - Net corporate bond issuance returned positive in 2011Q4 after being negative for several months, suggesting substitution from bank borrowing to bond issuance. - In 2012, the situation reversed: weak demand drove changes in credit more than supply. - After LTROs and other policy actions, estimated demand for credit fell well short of supply. - Historical perspective: - 12-month corporate credit growth fell sharply in the recent episode but the pace of slowdown has been somewhat milder than in the 1992–93 recession. - Four quarters since the start of the recession, nominal annual credit growth to the private sector declined by 5.4 percentage points, compared to declines of 13.2 and 11.0 percentage points respectively during corresponding periods in the early 1990s and 2008–09. ### Conclusions and policy implications - Main conclusions: - Volatility in the Italian sovereign debt market intensified since the summer of 2011, pushing up Italian banks’ funding costs and tightening lending conditions. - Shocks in investor risk appetite, euro area debt crisis news, and Italy-specific news have been important drivers of Italian sovereign spreads. - Italy’s high public debt and the large share of non-resident holdings of government debt amplified the impact of investor risk appetite shocks on spreads. - Italian banks’ CDS spreads exceeded those of euro area peers since summer 2011; sovereign spreads significantly contributed to widening this differential. - Banks with lower relative capital ratios and higher non-performing loans are more sensitive to changes in sovereign spreads. - Increases in sovereign spreads rapidly drive up firm lending rates (about 30-40 percent of the shock transmitted within a quarter). - Credit growth to Italian firms declined significantly, reflecting both weak demand and supply constraints; supply constraints prevailed at end-2011, while weak demand dominated in 2012. - Policy implications highlighted in the source: - Importance of reducing country-specific vulnerabilities to contain sovereign risks. - Need to address fragilities in the euro area at large to contain Italy’s sovereign risks. - Broader benefits from continued efforts to strengthen banks’ capital buffers and reduce impaired assets, given banks with lower capital and higher NPLs are more sensitive to sovereign shocks. *Source: _wp1384 - 2012. Co-movements among banks’ CDS (PDF chapter/section).* ### Appendix 1. Determinants of Italian Sovereign Spreads ### Appendix 1. Determinants of Italian Sovereign Spreads ### Regression results: daily changes in 10-year government bond spreads over the Bund - Dependent variable: Changes in the 10-year government bond spreads over the Bund. - Estimation details: - Equations were estimated at daily frequency over the period January 1, 2008-October 22, 2012, using instrumental variables. - Instruments were lagged changes in the VIX and lagged interaction terms between changes in the VIX and projected debt or the share of public debt securities held by non residents. - A constant was included among the regressors. - Statistically significant coefficients are bolded in the source. - Coefficient estimates and exact p-values (three reported specifications): - Lagged dep. variable: 0.05, 0.05, 0.07 - P-value: 0.04, 0.000, 0.00 - International bad news 2/: 13.16, 12.61, 12.99 - P-value: 0.000, 0.000, 0.00 - International good news 2/: -14.73, -14.36, -12.5 - P-value: 0.000, 0.000, 0.00 - Italy specific bad news 3/: 15.80, 15.74, 15.72 - P-value: 0.000, 0.000, 0.00 - Italy specific good news 3/: -38.37, -38.52, -38.3 - P-value: 0.000, 0.000, 0.00 - D(VIX): 1.96 - P-value: 0.01 - Projected debt * D(VIX): 0.02 - P-value: 0.01 - Share of debt held by foreigners * D(VIX): 0.04 - P-value: 0.01 - Sample size and fit: - Number of observations: 1252, 1252, 1171 - Adjusted R-squared: 0.18, 0.17, 0.17 - Notes on dummy variables: - 2/ Dummies capturing good and bad news related to international events related to the global crisis and the European debt crisis (details are reported in Appendix 2). - 3/ Dummies capturing good and bad news related to Italy specific events (details are reported in Appendix 2). ### Appendix 2: International/EU related events classified as "Bad" or "Good" news - International/EU — Bad (selected exact entries with dates as reported): - Bear Stearns bailout — March 14, 2008 - Lehman bankruptcy — September 15, 2008 - G-7 meeting fails to address Greek debt problem — February 7, 2010 - EU-IMF program on Greece announced — April 11 2010 - S&P downgrades Greece and Portugal — April 27, 2010 - Moody's publishes report warning on contagion risks from Greece and ECB disappoints expectations that it will support sovereign — May 6, 2010 - French and German governments agree to take steps that would make it possible to impose haircuts on government bonds — October 28, 2010 - Ireland requests EU-IMF program — November 21 2010 - EU-IMF Irish program is announced — November 28 2010 - Portugal's Minister of Finance says that the country will need international financial assistance — April 6, 2011 - Moody's downgrades Portugal. S&P says that French proposal on Greek debt rollover would constitute selective default — July 11, 2011 - Reports that Greek officials had failed to reach an agreement with representatives from the International Monetary Fund and the European Union on austerity measures to meet fiscal targets as part of the second bail-out package for Athens — September 5, 2011 - Euro zone finance ministers rejected an offer of Greek private sector involvement — January 23, 2012 - International/EU — Good (selected exact entries with dates as reported): - At the G-20 Finance Ministers meeting IMF funding is boosted — March 15, 2009 - 750 billion rescue package is announced — May 10, 2010 - EBA stress test results are published — 23 July 2010 - Finance ministers make clear that burden sharing would apply only to bonds issued after 2013 — November 12, 2010 - ECB announces that it would continue to provide exeptional liquidity support — December 2, 2010 - The European Commission says the size of the 440 billion European Financial Stability Facility must be reinforced and its application expanded — January 12, 2011 - European finance ministers decide to provide 500 billion euros for a new crisis fund that will come into force in 2013 — February 14, 2011 - At the eurozone summit Germany and France are expected to reach an agreement on an aid strategy for Greece. Stress test results are published — July 21, 2011 - IMF agrees to release disbursement for Greece — September 7, 2011 - First LTRO — December 21, 2011 - ECB debt swap removes obstacle to launch of PSI — February 17, 2012 - Second LTRO — February 29, 2012 - High participation in Greece's PSI deal is disclosed — March 9, 2012 - IMF approves new Greece's program — March 15, 2012 - European Union Summit — June 29, 2012 - President Draghi's speech suggesting ECB willingness to buy sovereign bonds in secondary markets — July 26, 2012 - ECB announces Outright Market Transactions program — September 6, 2012 - German Consitutional Court ruling on ESM and Fiscal Pact — September 12, 2012 ### Appendix 2: Italy related events (selected, with dates) - Italy — Bad: - Prime Minister's position weakens as he loses support from party members — September 11, 2011 - S&P's sovereign rating downgrade — September 19, 2011 - Moody's sovereign rating downgrade — October 4, 2011 - Fitch's sovereign rating downgrade — October 7, 2011 - After Prime Minister's resignation, uncertainty during the consultations to form a new government — November 12, 2011 - S&P's sovereign rating downgrade — January 14, 2012 - Moody's sovereign rating downgrade — February 13, 2012 - Italy — Good: - The ECB start buying Italian government bonds under the SMP program — August 8, 2011 - Italian government approves consolidation package (manovra d'Agosto) — August 12, 2011 - Monti consolidation package is announced — December 5, 2011 - Cabinet approves liberalization decree — January 20, 2012 - Parliament approves liberalization decree — March 24, 2012 - Parliament approves labor market reform — June 27, 2012 ### Appendix 3: Banks included in the sample for the analysis in Section III - Euro area banks: - Erste, Raiffesein, KBC, BNP Paribas, Credit Agricole, Societe Generale, Deutsche Bank, Commerzbank, Rabobank, ING group, Santander, Banco Bilbao Vizcaya Argenta. - Italian largest banks: - Unicredit, Intesa San Paolo, Monte dei Paschi, Banco Popolare, Unione Banche Italiane. ### Appendix 4. Estimated Credit Demand and Supply — quarterly estimates - Dependent variable: Quarterly percent changes in seasonally adjusted credit to firms. - Estimation details: - Equations were estimated over the period 2003Q1-2012Q3, using instrumental variables. - Instruments were the lagged lending standards and demand indicators from the Bank Lending Surveys and lagged lending rates. - A constant was included among the regressors. Bolded coefficients in the source are those statistically significant. - ISAE consumer confidence indicator used as proxy for expected economic activity. - Coefficient estimates and exact p-values (multiple specifications reported): - Lagged dep. Variable: 0.98, 0.86, 0.60, 0.74, 0.60, 0.86 - P-value: 0.000, 0.000, 0.01, 0.000, 0.01, 0.00 - Lending standards 2/: -0.01, -0.01, -0.01 - P-value: 0.01, 0.000, 0.00 - Demand indicator 3/: 0.01, 0.01, 0.01 - P-value: 0.000, 0.000, 0.00 - Lending rate: 0.5, 0.14, 0.50 - P-value: 0.03, 0.45, 0.03 - D(Confidence indicator) 4/: -0.13 - P-value: 0.17 - Fit statistics reported: - Adjusted R-squared: 0.86, 0.91, 0.87, 0.90, 0.000, 0.87 - Sources for Appendix 4: Bank of Italy; and IMF staff estimates. *Source: Appendix material titled "Appendix 1. Determinants of Italian Sovereign Spreads" from the supplied IMF PDF content.* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2013/_wp1384.pdf_