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Hazardous tango: sovereign-bank interdependence and financial stability in the euro area

  • Merler, S.
  • Pisani-Ferry, J.

The strong interdependence between banking and sovereign crisis has emerged as a salient feature of euro area crisis. This interdependence, for sure, is not a specific feature of the euro area. But as pointed out by several authors the vicious cycle seems to be extremely strong in the euro area. The reason why euro area banks and sovereigns seem to be indissolubly tied together is twofold. On one hand, in the absence of a supranational banking resolution framework, member states keep individual responsibility for the rescue of their national banking system. Given the size of the banking systems across the euro area, this implies that the fiscal consequences of rescuing banks are potentially very large and explains how stress in the banking system can spill over to sovereigns. On the other hand, domestic banks hold on their balance sheets a considerable share of the debt issued by their domestic government. Any doubt about sovereign solvency immediately therefore affects domestic banks. This two-way bank-sovereign interdependence constitutes one of the specific features of the euro area that renders it especially fragile. In spite of this demonstrated weakness there has been surprisingly little policy action to remedy this state of affairs. Proposals for giving the European Union or the euro area responsibility for rescuing banks, or at least backstopping national authorities, have been consistently rejected.

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File URL: http://www.banque-france.fr/fileadmin/user_upload/banque_de_france/publications/Revue_de_la_stabilite_financiere/2012/rsf-avril-2012/FSR16-article-19.pdf
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Article provided by Banque de France in its journal Financial Stability Review.

Volume (Year): (2012)
Issue (Month): 16 (April)
Pages: 201-210

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Handle: RePEc:bfr:fisrev:2011:16:19
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  1. Fabio Panetta & Thomas Faeh & Giuseppe Grande & Corrinne Ho & Michael King & Aviram Levy & Federico M. Signoretti & Marco Taboga & Andrea Zaghini, 2009. "An assessment of financial sector rescue programmes," Questioni di Economia e Finanza (Occasional Papers) 47, Bank of Italy, Economic Research and International Relations Area.
  2. Adrian Alter & Yves Stephan Schüler, 2011. "Credit Spead Interdependencies of European States and Banks during the Financial Crisis," Working Paper Series of the Department of Economics, University of Konstanz 2011-24, Department of Economics, University of Konstanz.
  3. Lane, Philip R., 2006. "The Real Effects of EMU," CEPR Discussion Papers 5536, C.E.P.R. Discussion Papers.
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  5. Jakob von Weizsäcker & Jacques Delpla, 2010. "The Blue Bond Proposal," Policy Briefs 403, Bruegel.
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  7. Carmen M. Reinhart & Kenneth S. Rogoff, 2011. "From Financial Crash to Debt Crisis," American Economic Review, American Economic Association, vol. 101(5), pages 1676-1706, August.
  8. International Monetary Fund, 2010. "European Financial Linkages; A New Look At Imbalances," IMF Working Papers 10/295, International Monetary Fund.
  9. Ashoka Mody & Damiano Sandri, 2012. "The eurozone crisis: how banks and sovereigns came to be joined at the hip," Economic Policy, CEPR;CES;MSH, vol. 27(70), pages 199-230, 04.
  10. Jean Pisani-Ferry, 2012. "The Euro crisis and the new impossible trinity," Policy Contributions 674, Bruegel.
  11. Viral Acharya & Itamar Drechsler & Philipp Schnabl, 2011. "A Pyrrhic Victory? Bank Bailouts and Sovereign Credit Risk," Working Papers 2012-004, Becker Friedman Institute for Research In Economics.
  12. Fabian Valencia & Luc Laeven, 2008. "Systemic Banking Crises; A New Database," IMF Working Papers 08/224, International Monetary Fund.
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  14. Silvia Merler & Jean Pisani-Ferry, 2012. "Who's afraid of sovereign bonds?," Policy Contributions 695, Bruegel.
  15. Ashoka Mody, 2009. "From Bear Stearns to Anglo Irish; How Eurozone Sovereign Spreads Related to Financial Sector Vulnerability," IMF Working Papers 09/108, International Monetary Fund.
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