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WP/2022/133

IMF Working Paper

European Department

Contagion as a Dealmaker?

The effect of financial spillovers on regional lending programs^*

Prepared by Alica Ida Bonk, Alexandra Fotiou and Georgios Manalis

Authorized for distribution by Khaled Sakr

IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.

Abstract

The recent European sovereign debt crisis highlighted the critical role of regional lending arrangements. For the first time, European mechanisms were called to design financing programmes for member countries in trouble. This paper analyses how the risk of contagion, an essential characteristic of interlinked economies, shapes borrowing conditions. We focus on the role of spillovers as a channel of bargaining power that a country might have when asking for financial support from regional lending institutions. We build and present a new database that records both the dates on which official meetings took place, relevant statements were released and the timing of the announcements regarding loan disbursements. This database allows us to assess the defining role that announcements of future actions have in mitigating spillover costs. In addition, we study the design of lending arrangements within a recursive contract between a lender and a sovereign country. When accounting for spillover costs, arising from the borrower to the creditor, we find that it is in the lender’s best interest to back-load consumption by giving more weight to future transfers in order to reduce contagion cost. Subsequently, we test and validate our theoretical predictions by assessing the effect of spillovers on loan disbursements to programme-countries and by juxtaposing lending conditions imposed by the IMF and the European mechanisms.

JEL Classification Numbers:	F34, F42, F45, H70, H81, H84
Keywords:	Regional lending mechanisms; currency-union; spillovers.
Author’s E-Mail Address:	alica.bonk@eui.eu; afotiou@imf.org; georgios.manalis@eui.eu

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JEL Classification Numbers:	F34, F42, F45, H70, H81, H84
Keywords:	Regional lending mechanisms; currency-union; spillovers.
Author’s E-Mail Address:	alica.bonk@eui.eu; afotiou@imf.org; georgios.manalis@eui.eu

Contents

• 1 Introduction

• 2 A New Dataset on Loan Announcements and Disbursements during the Euro Crisis

• 3 Empirical Analysis

  • 3.1 The Spillover Index – Vector Autoregressive Model

  • 3.2 Bivariate-GARCH Dynamic Conditional Correlation Model

  • 3.3 Spillovers and lending during the Euro crisis – A linear regression analysis

    • 3.3.1 The effect of lending programs on spillovers

• 4 A Recursive Contract Model with Spillover Costs

  • 4.1 Model

    • 4.1.1 Comparative statics with and without spillover effects

• 5 Discussion of Model Predictions

  • 5.1 Empirical Validation of Model Predictions

    • 5.1.1 Spillovers and the disbursement structure of European lending programs

• 6 Conclusion

• A Financial linkages across the euro area

• B Theoretical Appendix

• C Descriptive statistics from database on loan announcements and disbursements

  • C.1 Example statements

  • C.2 Descriptive statistics

  • C.3 Dynamics of announcements

• D Empirical Analysis

  • D.1 Evidence of Contagion – VAR Analysis and Spillover Index

• E Spillovers and loan conditions

• F The effect of announcements on spillovers – Summary tables

• G The effect of announcements on spillovers – Country details

  • G.1 Notes on the Portuguese lending programme

  • G.2 Notes on the Greek lending programme

    • G.2.1 1st Programme for Greece – Greek Loan Facility

• List of Figures

  • 1 Outstanding claims on Irish banks as a share of creditor country’s GDP in 2010 (Data source: BIS Consolidated banking statistics)

  • 2 Outstanding claims on Cypriot banks as a share of creditor country’s GDP in 2011 (Data source: BIS Consolidated banking statistics)

  • 3 Outstanding claims on Greek banks as a share of creditor country’s GDP in 2011 (Data source: BIS Consolidated banking statistics)

  • 4 Outstanding claims on Spanish banks as a share of creditor country’s GDP in 2011 (Data source: BIS Consolidated banking statistics)

  • 5 Outstanding claims on Portuguese banks as a share of creditor country’s GDP in 2011 (Data source: BIS Consolidated banking statistics)

  • 6 Share of general government gross debt held by foreign investors (Data source: IMF Sovereign Investor Base Dataset for Advanced Economies)

  • 7 Frequency of announcements by country

  • 8 Spillover measures and current consumption by country