Sovereign risk hits banks harder through marked-to-market holdings
Sovereign risk affects European banks more strongly when domestic government bonds are marked to market, Federal Reserve research finds. Evidence from 34 banks in 12 countries shows that stronger capital buffers moderate this exposure channel.
Accounting changes the transmission
Charlotte Hoopes, Pinar Uysal and Ilknur Zer combine daily credit default swap (CDS) spreads with supervisory sovereign exposures from October 2014 through December 2025.
For a 10 percent sovereign CDS increase, moving from the 10th to the 90th exposure percentile raises the bank CDS response by 2.4 percentage points for marked-to-market (MTM) holdings versus 1.7 for amortized-cost holdings.
The MTM exposure gap is about 40 percent larger; only its low-to-high difference is statistically distinguishable from zero.
MTM amplification is stronger at less-capitalized and wholesale-funded banks.
Peripheral banks show stronger average transmission and MTM amplification, while high market uncertainty strengthens average sovereign-bank comovement.
Less MTM, not less nexus
Average sovereign-bank sensitivity remains stable, but measured MTM amplification declines before and after the European Central Bank's June 2022 anti-fragmentation announcement.
Fixing each bank's exposure at its sample average substantially reduces that decline.
The MTM share falls from about 55 percent in 2018 to 36 percent by end-2025.
Higher public debt and interest burdens strengthen transmission; stronger fiscal balances weaken it.
Sovereign risk also depresses bank equity returns, with similar amplification from MTM and amortized-cost exposures.
Exposure is not causation
The authors interpret the estimates as exposure-conditioned sensitivities, not causal effects of sovereign holdings.
Accounting categories also differ in maturity, hedging and portfolio purpose.
The paper does not isolate reform effects, and its conclusions are not Federal Reserve Board views.