| Abstract : | Much attention has been given to the recent surge in sovereign bond yields in the euro area. Greece is the country to present the higher spread. While the spread of ten-year bond yield against Germany averaged 25 basis points between the introduction of the euro in 2002 to 2007, it rose sharply during the financial crisis. Greek government bonds are now traded with spreads over the German Bund previously associated with emerging market debt. In this thesis we seek to understand the fluctuations of the spread between the Greek and the German 10 year bonds and examine if the spread affects the activity of the banking sector. Although the financial crisis in the case of Greece was triggered by the sovereign deficit, the banking activity could not stay unharmed. We argue that banking and sovereign risk has become increasingly interconnected. The adoption of rescue packages for the financial sector highlights the relationship between them. The spread will allow us to gauge the pass through tensions. Most people would agree that in good economic times the banking sector operates as a beneficial source of revenue for the government and a driver of economic growth. While the government faces fiscal deficits, the aggregate risk increases and banks are immediately absorbing the sovereign risk in several ways. The price channel, the balance sheet channel and the liquidity channel are the primarily channels to be affected by the sovereign spread tensions. Of course, the pass through tensions differ among the banks in response to the diversification, the business models and lending strategies they follow. In the case of Greece, the omens for development and progress came to halt when the crisis showed the unstable fundamentals and the deficit of the economy reached its peak leading the country no other solution but to ask for rescue packages. A display of the main events since the entrance of Greece in the euro-zone and the outburst of the financial crisis helps us explain the main channels suggested for the transmission of government bond market in the Greek environment. We will explain them in an aggregate level. The reformulation of the banking sector does not allow us yet to investigate it among the Greek banks. Econometrically, I use the 10-year spread of the Greek bonds vs their German counterparts as an explanatory variable on a wide array of bank lending and funding interest rates. Different time horizons of interest rates are exploited to assess to what extent the transmission of sovereign risk differ in relation with the investment horizon. Regarding the cost of loans, the sovereign spread significantly affects firms. In households the tensions are passed through only when we use a dummy to gauge for sovereign crisis. In the liability side, the spread has an effect in the deposit rates but slighter than its effect in the lending rates. Overall, the financial crisis affected the deposit interest rates by turning the effect of the spread negative. Surprisingly, the spread of overnight firms‟ deposits show positive impact during crisis.
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