Analysing credit risk in large local governments: an empirical study in Spain

In governments throughout the world, bank lending excesses, solvency issues and worsening credit ratings have all contributed to raising risk premiums and impeding access to credit, thus provoking a major financial problem in the public sector. Accordingly, tax authorities and regulators need to analyse the causes of public sector bank debt, doing so through the joint study of idiosyncratic and systematic variables, an area that has been neglected in previous research. This paper examines idiosyncratic and systematic factors that may influence local government credit risk through an empirical study of the performance of 148 large Spanish municipalities during 2006–2011. We identify individual factors relevant to the probability of local government default (such as dependent population, per capita income and debt composition) and also determinants associated with macroeconomic developments, such as gross domestic product and the risk premium.