Search

Studies have shown that political variables can infl uence the volume of government debt and have recommended investigating the joint effects of diverse factors on the risk of local government default. Considering the relation between economic management and political constraints, this paper examines the joint infl uence of political and systemic factors on the risk of loan default by Spanish local governments. To do so, we analyze 148 city councils for the period 2006-2011, using a logit model with panel data and an artifi cial neural network. The empirical results indicate that the fi nancial risk of local governments is affected both by political factors specifi c to each case and, simultaneously, by systemic variables for the country. Specifi cally, political variables such as the mayor not having economics-related university studies, the under-representation of female councilors in the municipal corporation, municipal government by a party with a progressive ideology, and ideological alignment between the municipal and the regional government are all associated with greater fi nancial risk. Moreover, rising national unemployment, an increased sovereign risk premium, the impact of the electoral cycle, and that of declining economic growth are all factors that may increase the risk of default. The fi ndings presented are of great potential interest for governments, managers, national and international fi scal authorities, fi nancial regulators, and citizens at large, because an understanding of the signifi cance of these variables can help authorities make appropriate decisions to prevent and/or overcome problems related to municipal insolvency.

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.

Concern has been expressed by international organisations and in previous studies about the financial situation of local governments, and the question of debt has been identified as a crucial element in efforts to overcome the current financial crisis. However, the variables that can affect the financial soundness of these governments have not been sufficiently studied, despite their direct relation to the credit risk premium. In this article, we aim to identify risk factors for default by local governments, and provide useful information to municipal financial managers. We conducted an empirical study of 148 Spanish municipalities and analysed data from four years, applying a random effects logistic regression model. Our findings reveal that a lower population density, less dependent population, falling levels of per capita income and the presence of progressive local government are all risk factors for default by local governments. Furthermore, our findings indicate that the general financing structure variable and debt composition and maturity variable do influence the risk of default by local governments. Points for practitioners The findings of this article can provide useful information for managers and politicians responsible for the financial management of local governments, in particular, by enabling them to better understand the risk premiums assigned by banks. Specifically, by identifying the risk factors for default, this article highlights the warning signs of this risk, so that suitable arguments may be expressed in negotiating loan repayment schedules and interest rates, and in designing financial viability and restructuring plans.

Previous studies have highlighted the question of government loan interest as one of great current importance. Government borrowing levels are high, and reducing interest payments would generate savings to meet other spending needs and/or to lower taxation, thus supporting the sustainability of public finances. However, no previous study has presented a method for a local government to calculate its own credit risk and thus be in a position to negotiate lower interest rates on its borrowing. This article defines a financial model that enables local governments to estimate the interest rate payable on a bank loan, based on their credit risk premium, in accordance with the Basel II rules and the findings of our empirical study of large local governments.