This paper aims at investigating some of the critical issues highlighted by the sovereign debt crisis in European Union Member States.
The goal is twofold:
1) Quantify, via a development of the SYMBOL model here firstly presented, the impact in terms of higher risk for the EU banking systems of haircuts of sovereign debts of some EU MS, which have been particularly touched by the sovereign crisis;
2) evaluate and compare the policy options which have been adopted to address the issue.
In particular the analysis compares the measures within the Basel III Accord, which increases the quality and quantity of capital that banks should set aside to cover from unexpected losses, with the agreement on bank recapitalisation and funding reached by the European Council in October 2011, which responded to the urgent consequences of the sovereign bonds crisis in the EU.
The analysis is performed on 65 of the large EU banking groups identified by the European Banking Authority, via a futher development of the SYMBOL model that allows estimating the banks PD without Monte Carlo simulations.
Results show that the haircuts on sovereign debts of EU MS in crisis would heavily worsen the stability of their banking systems but could also sometimes affect financial stability of other EU countries. We also show that the creation of a temporary capital buffer in the form of a capital target, necessitated by the exceptional circumstances prevailing in some EU MS, represent a step forward to Basel III rules.JRC.G.1-Scientific Support to Financial Analysi
