Financial contagion and its transmission channels between PIIGS economies

FACULTY OF FINANCE, INSURANCE, BANKING AND STOCK EXCHANGE (FABBV) wi hin Bucha es Academy o Economic S udies SIF BANAT-CRIŞANA ASOCIAŢIA ROMÂNĂ DE FINANŢE-BĂNCI – RoFIBA (Romanian Associa ion o Finance and Banking – RoFIBA) In e na ional Finance and Banking Con e ence FI BA 2013 (XI h Edi ion) MARCH 28-29, 2013 Bucha es , Romania Theo e ical and Applied Economics. Supplemen  538 FINANCIAL CONTAGION AND ITS TRANSMISSION CHANNELS BETWEEN PIIGS ECONOMIES Daniela ZĂPODEANU Uni e si y o O adea [email p o ec ed], [email p o ec ed] Edina KULCSAR Uni e si y o O adea [email p o ec ed] So ina Ioana PETRIŞ Uni e si y o O adea [email p o ec ed] Abs ac . This pape iden i ies he mos impo an simila i ies be ween he ou PIGS coun ies: Po ugal, I aly, G eece and Spain, in e ms o p inciple mac oeconomic indica o s in he cu en c isis. This a icle also ea s he p inciple ansmission channels o so e eign isk and implici ly he inancial c ises. These ansmission channels a e he ollowing: inc ease in so e eign bond yields, c i ically budge a y posi ion, banks' exposu es owa d PIIGS economies and o he s a es banks' exposu es o so e eign deb o he PIIGS s a es. S udying he ansmission channels o so e eign isk, esul s ha , he Eu opean F amewo k is unde ins i u ional e o m, bu i should be imp o ed in e ms o ins umen s which quan i y inancial s abili y and c ises p e en ion. Keywo ds: inancial con agion; public deb ; inancial s abili y; public de ici ; exposu e. JEL Classi ica ion: E50, E60, E62, G01, H62. REL Classi ica ion: 11C, 8J. 1. In oduc ion The inancial c isis e ealed he weaknesses ax o EU coun ies, b inging o he o e a conce n o s a es known unde he ac onym PIIGS namely: Po ugal, I aly, I eland, G eece and Spain. The speci ic o hese s a es is he c i ical iscal posi ion and i s in luence on inancial s abili y amewo k. I we look a he c isis as a deb c isis, we can igno e I eland, as I eland's deb espec ed he con e gence c i e ia, since he adop ion o he Eu o. Ano he c i e ion o di e en ia ing I eland om PIGS is he geog aphic co e age o he ou coun ies (S, SW Eu ope), which acili a es ade de elopmen be ween hem. So e eign c edi isk managemen has a signi ican impac on inancial s abili y. Gi en his, we p opose in his pape o analyze he main channels o con agion, ha con ibu ed o he sp ead o so e eign c edi isk o iden i y simila i ies and di e ences o PIGS - I eland ha cha ac e ize hese s a es, di ec ion o sp eading i among s a es, possibili y o s op he inancial c isis and po en ial ways o quan i ying he s abili y/ inancial ins abili y. Acco ding o he Eu opean Cen al Bank, o which we subsc ibe, he e a e a ious channels o con agion o so e eign c edi isk. 2. Channels o con agion o so e eign c edi isk The i s channel o con agion is de e io a ing c edi g ow h due o so e eign deb , which esul ed in an inc ease in so e eign bond yields (ECB, 2010, 76 p.). In e na ional Finance and Banking Con e ence. Session VI. Banking 539 Sou ce: h p://epp.eu os a .ec.eu opa.eu Figu e 1. The e olu ion o long- e m bond yields in he PIIGS (2006-2012) As shown in Figu e 1, pe o mance bonds o G eece came in 2010 o 11.03, egis e ing an inc ease o 73%. Spain's go e nmen bond yields inc eased mode a ely a s a o he pe iod 2006 o he hi d qua e o 2010. Po uguese bonds wi h a ma u i y o 30 yea s eached 5.57 pe cen age poin s, an inc ease o 44% om ecen lows. A he end o 2011 and he beginning o 2012, we assis o an imp o emen in e ms o PIIGS economies bond yields, despi e he ac ha in some cases i ’s s ill c i ical: G eece, I eland and Po ugal (Table 1, Appendix). The second channel o con agion is he ax namely he excessi e de ici s, which inc ease long- e m in e es a es and isk p emiums leading o an inc ease in he cos o bo owing. Sou ce: h p://epp.eu os a .ec.eu opa.eu Figu e 2. E olu ion o he budge de ici in 2006-2011 (% in GDP) Inc eased so e eign ulne abili y, s a es can ansla e in o ch onic budge de ici s, which esul ed in highe le els o deb de aul wi h wo sening g ow h po en ial. Coun ies wi h weak iscal posi ion eached eco d double-digi de ici s, G eece in 2009 eached a de ici o 15.6% o GDP, ollowed by I eland wi h a de ici o 13.9% o GDP and 11.2% o GDP Spain. In e ms o sha e in GDP, he public de ici o I eland eco ded a wo sening again in 2010, eaching o e 35% o GDP, ollowed by a dec ease in 2011 (Table 2, Appendix). In o he analyzed economies, we can obse e an imp o emen o public de ici , bu wi hou ouching he 3% a ge imposed by Maas ich T ea y. Theo e ical and Applied Economics. Supplemen  540 I aly wi h a lowe budge de ici o 5.4% o GDP is acing a e y high public deb . Excessi e de ici s indica e he end o apid g ow h and inc eased ulne abili y o deb inancial posi ion o a s a e. Ano he common ea u e o he ou analyzed coun ies e e o high public deb espec i ely exceeds 100% o GDP in he second qua e o 2010 (148.3% o GDP G eece and I aly 119.2% o GDP, wi h such high ax isk go e nmen deb o G eece p o es o be oo la ge o be paid, one o he p ima y p oblems is ha he in e na ional communi y lacks a amewo k o deal wi h such si ua ions. In 2011, he succession o hese i e economies emains unchanged in e ms o public deb . The highe public deb , bigge han 100% om GDP is p esen ed by G eece (170.6% o GDP), I aly (120.7% o GDP), ollowed by Po ugal (108.1% o GDP) and I eland (106.4%) (Table 3, Appendix). Spain, Po ugal aces a le el high indeb edness o he p i a e sec o . Inc ease e inancing cos s o he go e nmen means addi ional e o s and p i a e sec o deb e inancing, esul ing sp ead iscal p oblems in he p i a e sec o . Sou ce: h p://epp.eu os a .ec.eu opa.eu Figu e 3. The e olu ion o public deb (% in GDP), 2006-2011 The apid g ow h o public deb and budge balance de e io a ion may comp omise inancial s abili y as so e eign shocks a e ansmi ed o he banking sys em ha can help o sp ead ac oss bo de s. In his key ask o cen al go e nmen is o design medium- e m iscal consolida ion s a egy aimed a clea sho s deb mi iga ion and eme gency esponse in de e io a ing public budge . T ansmission o so e eign isk on local banking sys ems and i s e ec s on he eal economy is a h ea o global inancial s abili y. The hi d channel o con agion could be h ough he banking sys em (Table 4, Appendix). Quan i ica ion o con amina ion can be achie ed by analyzing banks' exposu es owa d ou PIGS economies (Po ugal, I aly, G eece and Spain). As a esul o inancing di icul ies aced by G eece end o di e en ia e ma ke s in he eu o a ea banks' exposu e c i e ion o hese economies (IMF-a, 2010, p. 4). F ench and Du ch banks ha e signi ican exposu es in he banking sys em in Spain. I no esume g ow h and no implemen ing iscal consolida ion measu es, conce ns will go on public inances o Spain. High in e es a es in Spain can highligh he weaknesses o Spanish inancial sys em. Sa ings banks, especially he "Cajas" ace bad loans caused by de e io a ing housing ma ke and inc eased cos o unding. Conce ns o e he inances o a coun y may be ansmi ed o o he inancial sys ems. Exposu es o banks in Belgium, I eland and Ne he lands o I aly and Spain a e signi ican . Thus hese s a es a e ex a ulne able o wo sening iscal p oblems (Financial S abili y Repo , 2010, p. 23). In e na ional Finance and Banking Con e ence. Session VI. Banking 541 Table 1 Banks' exposu e le el o he PIIGS (% GDP) in 2010 G eece I eland I aly Po ugal Spain To al F ance 0-5 0-5 15-20 0-5 5-10 33 Ge many 0-5 5-10 5-10 0-5 5-10 21 Holand 0-5 0-5 10-15 0-5 15-20 31 Spain 0-5 0-5 0-5 5-10 - 10 Belgium 0-5 5-10 5-10 0-5 0-5 21 I eland 0-5 - 15-20 0-5 10-15 40 I aly 0-5 0-5 - 0-5 0-5 3 Po ugal 0-5 0-5 0-5 - 10-15 23 G eece - 0-5 0-5 0-5 0-5 <1 Sou ce: Financial S abili y Repo , “Financial un es in Eu ope –possible consequences o inancial s abili y in Sweden”, Janua y 2010, p. 23. The ou h channel, which can con amina e he inancial sys em is ha banks esiden in coun ies wi h excessi e de ici s a e holde s o go e nmen deb . Sou ce: Banca D’I alia, Eu osis ema, “Financial S abili y Repo ”, Decembe 2010, p. 20. Figu e 4. Sp ead he so e eign CDS and bank in 2010 Following an analysis o he Eu o a ea, i was ound ha an inc ease o 100% go e nmen bond yield inc eases o 10-20% co po a e bond yields in he eu o a ea as a whole (ECB, 2010, p. 77). Mo eo e , he si ua ion is ampli ied in he case o banks: go e nmen in e en ion om he eu o a ea o suppo he inancial ins i u ions has diminished he dis inc ion be ween so e eign and p i a e deb he eby ans e ing isk om he banking sys em by go e nmen al sec o , which esul ed in a close co ela ion be ween he sp ead he bank CDS(1) and so e eign. This close ela ionship esul ed in highe sp eads o banks, esul ing in inc eased inancing cos s. So, he g ow h o he yield bonds may weaken he banking ac i i y, because o he dec eased ma ke alue o he po olio. App oxima ely 50% o long- e m bond ma ke a e issued by eu o a ea coun ies and held by banks om he eu o a ea, some o hem wi h high le els o exposu e o go e nmen s. Theo e ical and Applied Economics. Supplemen  542 Sou ce: Ad ian Blundell-Wignall and Pa ick Slo ik, “The EU S ess Tes and So e eign Deb Exposu es”, Augus 2010, p. 8 Figu e 5. Banks' exposu es o so e eign deb o he PIIGS (million Eu o) Looking a he cha (Table 5, Appendix) abo e, we see ha banks end o be exposed o he so e eign deb o he coun y esides. This ule is no alid in he case o I eland, whe e a signi ican p opo ion o exposu e o public deb is owned by Ge many, ollowed by G ea B i ain. This is ano he di e ence o I eland compa ed o he ou PIGS coun ies. 3. Di ec ion o con agion In he ea ly s ages o he c isis, F ance and Ge many, he heal hy co e o Eu ozone bene i ed om inc eased isk a e sion. A e he collapse o Lehman B o he s, s a es ha eac ed nega i ely on o he so e eigns issue s, ha e been hi ha d by he inancial c isis. These coun ies we e Aus ia, I eland and he Ne he lands. Some s a es ha e in luenced hei go e nmen balance - public budge , o suppo banks, which imp o ed he conce ns ega ding he sys emic c isis and he isk a e sion dec eased. Bu he inancial c isis has u ned in o economies wi h weak iscal ou look and inancial ensions. These ensions we e mos e iden in G eece. I we we e o gi e back he main s ages o he inancial c isis, ch onologically and spa ially, we can dis inguish he ollowing s eps in d awing he schedule o conduc ing inancial c isis: Launch o he sys emic c isis Sys emic ou b eak Sys emic eply (07. 2007- 09.2008) (10. 2008 – 03.2009) (04.2009 – 10.2009) F ance, Ge many suppo ed Aus ia, Belgium, I eland Policy suppo lead banks by he inc eased isk and Holland, coun ies wi h o educe isk a e sion. a e sion send he isks inancial conce ns come o o he economies. o he o e. So e eign isk (11.2009 - p esen ) Coun ies wi h iscal p oblems (G eece, I aly, Po ugal, Spain) ha e an impo an con ibu ion o he sp ead o inancial c isis (IMF-b, 2010: 7p.) In e na ional Finance and Banking Con e ence. Session VI. Banking 543 Coun ies wi h iscal p oblems (G eece, I aly, Po ugal, Spain) ha e an impo an con ibu ion o he sp ead o inancial c isis (IMF-b, 2010, p. 7) Ano he signi ican di e ence be ween I eland and he PIGS s a es is in e ms o empo al scale deploymen inancial c isis. I eland comes o he o e in Oc obe 2008, con ibu ing o he ou b eak o sys emic c isis, compa ed wi h PIGS s a es ha a e eme ging in he con ex o he ansmission o so e eign isk, un il No embe 2009. Rega ding he con ibu ion o isk p opaga ion, i can be obse ed he signi ican con ibu ion o he analyzed s a es. The main con ibu o s o ans e he so e eign isk a e G eece and Po ugal, ollowed by Spain and I aly, in o de men ioned. 4. Ways o quan i ying he inancial s abili y The c isis has shown ha he sys em o inancial supe ision in Eu ope is inadequa e scale in eg a ed in EU inancial se ices ma ke . Impo ance o sys emic isks la ely led o he conclusion ha he emphasis should all on mac o-p uden ial egula ion and no on mic o- p uden ial egula ion. Mic o-p uden ial egula ion conce ns he p o ec ion and egula ion o indi idual ins i u ions and mac o-p uden ial egula ion e e s o he isk o collapse o inancial sys ems, conside ed as a whole. I is necessa y o ha e simul aneously wo ypes o egula ion, because hey a e in e connec ed. Indica o s o inancial s abili y and sys emic isk measu es he cu en le el o ins abili y and sys emic s ess. A comple e mac o-p uden ial analysis equi es ha he inancial s abili y indica o s o be a ailable and ele an o each ma ke and ma ke in as uc u e, in e media e, and combina ions o hese componen s, in he inancial sub- sec o s and in he inancial sys em as a whole. Using indica o s o sys emic isk and inancial s abili y o mac o-p uden ial bodies is jus i ied by hei ypical ask o iden i ying sys emic isks and issuing wa nings abou he inc eased isks. Mo eo e , he a ailabili y o sys emic s abili y indica o s can se e as an inpu o iden i y eme gencies. An ad an age o hese indica o s is ha hey can be de eloped o all ele an sys emic in e media ies and ma ke s. Mo eo e , he se o indica o s can be expanded ela i ely apidly and lexibly, depending on he speci ic p oblems o in e es a some poin in ime, and in esponse o inno a ion and s uc u al change in he inancial sys em. This is why mac o-p uden ial au ho i ies should ha e a comp ehensi e se o indica o s o inancial s abili y a hei disposal and o con inuously e iew and upda e ex ensions. Composi e indica o o sys emic s ess ("CISS") de eloped by he Eu opean Cen al Bank, allowing eal- ime moni o ing and assessing he le el o s ess in he inancial sys em, also helps o delimi and cha ac e ize his o ical episodes o " inancial c isis". This indica o could be used o assess he impac o he policy measu es o educe sys emic s ess le els. Fo cu en assump ions c isis, and conside ing he cu en s a e o global in e connec ion o economic ma ke s, i is impo an o analyze he con agion o inancial ins abili y. This is ex emely impo an o examine in he case o he coun ies we analyzed. Building an agg ega e inancial s abili y index (ISF) is one o he quan i a i e me hods which measu e he s abili y o a inancial sys em along wi h ea ly wa ning sys ems and s ess es s. Ea ly wa ning sys ems allow he p edic ions o he p obabili y o a inancial c isis, bu does no p o ide in o ma ion abou he capaci y o espond o shocks, espec i ely ha echniques such as “s ess es ing”, which enable compa isons be ween he pe o mance o s abili y o di e en pe iods o be ween he s abili y o inancial sys ems. Compa ed wi h ea ly wa ning sys ems, agg ega e inancial s abili y index (ISF) o e s he possibili y o making compa isons be ween di e en pe iods and sys ems and also obse e he de elopmen le el o s abili y. E en hough his echnique is conside ed simple, igid and mechanical, i has many ad an ages o e o he me hods: high anspa ency, can mo e easily iden i y he necessa y s a is ical da a and simplici y o calcula ions. To de e mine he ISF is calcula ed h ee Theo e ical and Applied Economics. Supplemen  544 composi e indices – Financial De elopmen Index (IDF), Financial Vulne abili y Index (IVF) and Financial Soundness Indica o s (FSI) – he sum gi es ise o agg ega e inancial s abili y index (ISF). In he e en o una ailable da a, composi e indica o can be calcula ed as he a e age o a ailable indica o s. 4 4 1 ∑ = =jdj i IDF ; 6 6 1 ∑ = =j j i IVF ; 5 5 1 ∑ = =jsj i FSI Thus, indi idual indica o s used in de e mining composi e indica o s a e: (i) o he IDF: To al c edi /GDP, Bank ma gin, Ma ke capi aliza ion/GDP, Banking e o m and he in e es o libe aliza ion; (ii.) o IVF: NGO C edi /To al C edi (Rese es/Deposi s)/(Cash/M2), In la ion a e, Budge de ici /GDP, Loans/Deposi s, Bank deposi s a ia ion/Va ia ion M2; (iii.) o SWFs: Nonpe o ming Loans/To al Loans, Equi y/To al Asse s, Regula o y capi al/Risk-weigh ed asse s, Liquid asse s/To al asse s (%) ROA (Albulescu, 2009, p. 77). Agg ega e Financial S abili y Index (ISF) is ob ained by summing he h ee composi e indica o s. Conclusions Con agion and spillo e models a e used p ima ily o assess c oss- ansmission o inancial ins abili y (ECB, 2010, p. 144). A s ic de ini ion app oach de i ed om he con agion e ec is gi en by Kaminsky and Reinha and Eicheng een and Rose: “con agion e ec is he si ua ion whe e in o ma ion abou he exis ence o a c isis in ano he coun y inc eases he p obabili y o a c isis in he local plan” (Păun, 2010, p. 2). P ice s abili y does no ensu e inancial s abili y, and no e e y p oblem has a iscal o igin (eg. Spain), e asion o egula ion and supe ision o inancial ma ke s c ea es majo sys emic isk and excessi e le e age p i a e sec o (banks) gi es ise o sys emic isks. Due o he ex emely high deg ee o in e connec ion wi hin he EU coun ies, and hence he PIGS s a es, is di icul o s op he con agion be ween economies o hese coun ies, since he c isis and p oblems in hese economies al eady exis s. Eu opean amewo k o inancial s abili y a his ime is unable o s op he nega i e e ec s o con agion, Eu opean au ho i ies a e cu en ly powe less o in luence he nega i e e ec s o economic down u n sp ead among he coun ies analyzed. Po ugal, I aly, G eece and Spain a e he coun ies in he Eu o zone and adop ed he single cu ency eu o. This means ha adjus men s in hese coun ies can be made only by iscal and s uc u al e o ms, a he han by adjus ing na ional cu ency, i s de alua ion. In ou opinion, he bes solu ions o ensu e inancial s abili y objec i e should ake in o accoun he con adic ions gene a ed by imposing a single cu ency in coun ies wi h di e en iscal policies. Since he adop ion o he eu o, he ou PIGS s a es acing budge de ici s and public deb bu den, causes unce ain y in he si ua ion in each coun y is di e en , howe e . I aly and G eece, despi e he ac ha does no comply wi h he con e gence c i e ia on public deb and ha e high p e-c isis deb , a e s ill suppo ed in he eu o a ea. Howe e , he wo coun ies ha e op ed o deb weigh ing agains he adop ion o aus e i y policies, which led o a ch onic deb si ua ion and he expansion o o he s a es wi h poo iscal posi ions. A he same ime, impo ance o sys emic isks la ely led o he conclusion ha he emphasis should all on mac o-p uden ial egula ion and no on mic o-p uden ial egula ion. Bu no o ge o ake in o accoun he in e ela ionship be ween mic o and mac o egula ions. We belie e ha , in o de o a oid u u e inancial c ises, he ask o he Eu opean su eillance cu en ly co e ing classical, adi ional gea ed mo e owa ds egula ion and legisla ion, should in u u e be complemen ed by su eillance based on iden i ica ion, p e en ion indica o s ha quan i y inancial c isis. In e na ional Finance and Banking Con e ence. Session VI. Banking 545 No e: (1) CDS- C edi De aul Swap - is a swap con ac in which he p o ec ion buye makes pe iodic paymen s (sp ead) o he selle and punching exchange, ecei es a ce ain amoun i he c edi (loan o bond) su e s an unexpec ed e en (no eimbu sed). 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