ESMT White Paper

Breaking the doom loop: The euro zone basket

ESMT White Paper No. WP-17-01
Dietrich Matthes, Jörg Rocholl (2017)
Subject(s): Economics, politics and business environment, Finance, accounting and corporate governance
Keyword(s): Sovereign-bank nexus, bank regulation, sovereign debt, financial integration, banking crisis
JEL Code(s): G01, G20, G28, H63

This paper develops a new suggestion on how to break the sovereign-bank nexus. This nexus, which is due to significant holdings of domestic sovereign debt by Euro zone banks, endangers financial stability. Our suggestion does not involve pooling and/or tranching and is fully consistent with standard Basel capital requirements. At the same time, it does not require capital provision for sovereign portfolios held as collateral for liquidity operations with the lender of last resort (LOLR). Rather, it differentiates between the purpose of collateral for LOLR liquidity operations and the individual investment decision of which sovereign debt to hold. In this way, our methodology is market-driven and can foster financial integration in Europe.

Pages 17
Publication Nr. WP-17-01
ISSN 1866–4016 (Print)