Corporate Governance and the Sovereign-Bank Nexus: How Board Expertise and Capital Adequacy Moderate the Credit Risk-Sovereign Exposure Channel

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Abstract
This paper examines how corporate governance structures and capital adequacy jointly shape the relationship between credit risk and sovereign debt allocation. Using an international sample of 498 listed banks, comprising 2,668 observations from 45 countries over the period 2015–2024, we find that board-specific skills are the primary governance moderator, with results robust across specifications. Capital adequacy plays a key role in this relationship: board skills significantly moderate the association between credit risk and sovereign debt allocation in well-capitalized banks, but not in capital-constrained banks. In terms of economic significance, a simultaneous one-standard-deviation increase in board skills and non-performing loans reduces sovereign debt allocation by 21 basis points, equivalent to 3.4% of mean holdings. Governance moderation is mainly observed among non-US banks, where sovereign exposure appears to reflect concentrated risk, with both board skills and affiliations playing a significant role. By contrast, this effect is largely absent among US banks, where sovereign holdings are more consistent with safe-asset demand. Finally, a principal component analysis confirms that composite governance indices may mask dimension-specific effects.

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