Non-performing loans and sovereign credit ratings

Abstract

This paper examines the joint behaviour of sovereign ratings and their macroeconomic/financial determinants (namely uncertainty, GDP growth, government debt-to-GDP ratio, investment-to-GDP ratio and the fiscal balance-to-GDP ratio) in a multivariate Panel Vector Autoregressive (PVAR) framework. We reveal another channel of interconnection between sovereign and banking credit risk by identifying a two-way relationship between non-performing loans (NPLs) and sovereign ratings. Generalized impulse response functions (GIRFs) provide evidence of significant effects from NPLs on sovereign rating decisions over and above the effects of the remaining economic/financial variables. At the same time, sovereign rating decisions impact on NPLs and all other variables.