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Regulating the Doom Loop

Author

Listed:
  • Spyros Alogoskoufis

    (European Central Bank)

  • Sam Langfield

    (European Central Bank)

Abstract

Euro-area governments have committed to break the doom loop between banks and sovereigns. But policymakers disagree on how to treat sovereign exposures in bank regulation. Our contribution is to model endogenous sovereign portfolio reallocation by banks in response to regulatory reform. Simulations highlight a tension between concentration and credit risk in portfolio reallocation. Resolving this tension requires regulatory reform to be complemented by an expansion in the portfolio opportunity set to include an area-wide low-risk asset. By reinvesting into such an asset, banks would reduce both their concentration and their credit risk exposure.

Suggested Citation

  • Spyros Alogoskoufis & Sam Langfield, 2020. "Regulating the Doom Loop," International Journal of Central Banking, International Journal of Central Banking, vol. 16(4), pages 251-292, September.
    • Handle: RePEc:ijc:ijcjou:y:2020:q:3:a:6
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    2. Helge Berger & Giovanni Dell’Ariccia & Maurice Obstfeld, 2019. "Revisiting the Economic Case for Fiscal Union in the Euro Area," IMF Economic Review, Palgrave Macmillan;International Monetary Fund, vol. 67(3), pages 657-683, September.
    3. De Sola Perea, Maite & Dunne, Peter G. & Puhl, Martin & Reininger, Thomas, 2019. "Sovereign bond-backed securities: A VAR-for-VaR and marginal expected shortfall assessment," Journal of Empirical Finance, Elsevier, vol. 53(C), pages 33-52.
    4. Carmen M. Reinhart & Franziska L. Ohnsorge & Kenneth S. Rogoff & M. Ayhan Kose, 2022. "The Aftermath of Debt Surges," Annual Review of Economics, Annual Reviews, vol. 14(1), pages 637-663, August.
    5. Sam Langfield, 2020. "Bridge over Troubled Monetary Union: A Reply to De Grauwe & Ji," Journal of Common Market Studies, Wiley Blackwell, vol. 58(S1), pages 1-10, September.
    6. Philip R. Lane, 2021. "The Resilience of the Euro," Journal of Economic Perspectives, American Economic Association, vol. 35(2), pages 3-22, Spring.
    7. Soenen, Nicolas & Vander Vennet, Rudi, 2022. "Determinants of European banks’ default risk," Finance Research Letters, Elsevier, vol. 47(PA).
    8. Lorenzo Codogno & Paul Noord, 2022. "Assessing Next Generation EU," Springer Proceedings in Business and Economics, in: Luigi Paganetto (ed.), Economic Challenges for Europe After the Pandemic, pages 59-82, Springer.
    9. Hristov, Nikolay & Hülsewig, Oliver & Kolb, Benedikt, 2021. "Macroprudential policy and the sovereign-bank nexus in the euro area," Discussion Papers 32/2021, Deutsche Bundesbank.
    10. Antonija Buljan & Milan Deskar-Skrbic & Mirna Dumicic, 2020. "What drives banks’ appetite for sovereign debt in CEE countries?," Public Sector Economics, Institute of Public Finance, vol. 44(2), pages 179-201.
    11. Vojtěch Siuda & Milan Szabo, 2021. "Measuring Sovereign Credit Risk of the EU countries," Journal of Central Banking Theory and Practice, Central bank of Montenegro, vol. 10(3), pages 169-192.
    12. Nicolas Soenen & Rudi Vander Vennet, 2020. "ECB Monetary Policy and Bank Default Risk," Working Papers of Faculty of Economics and Business Administration, Ghent University, Belgium 20/997, Ghent University, Faculty of Economics and Business Administration.
    13. Cronin, David & Dunne, Peter G., 2019. "How effective are sovereign bond-backed securities as a spillover prevention device?," Journal of International Money and Finance, Elsevier, vol. 96(C), pages 49-66.
    14. Thierry Warin & Aleksandar Stojkov, 2021. "Banks’ Foreign Claims in the Aftermath of the 2008 Crisis: Institutional Response, Financial Efficiency, and Integration of Cross-Border Banking in the Euro Area," JRFM, MDPI, vol. 14(2), pages 1-17, February.
    15. Jay Cullen, 2022. "“Economically inefficient and legally untenable”: constitutional limitations on the introduction of central bank digital currencies in the EU," Journal of Banking Regulation, Palgrave Macmillan, vol. 23(1), pages 31-41, March.
    16. Nadal De Simone, Francisco, 2021. "Measuring the deadly embrace: Systemic and sovereign risks," Research in International Business and Finance, Elsevier, vol. 56(C).

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    JEL classification:

    • G01 - Financial Economics - - General - - - Financial Crises
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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