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Regulating the doom loop

Author

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  • Alogoskoufis, Spyros
  • Langfield, Sam

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 contributionis to model endogenous sovereign portfolio reallocation by banks in response toregulatory reform. Simulations highlight a tension between concentration and credit risk inportfolio reallocation. Resolving this tension requires regulatory reform to be complementedby an expansion in the portfolio opportunity set to include an area-wide low-risk asset. Byreinvesting into such an asset, banks would reduce both their concentration and credit riskexposure. JEL Classification: G01, G11, G21, G28

Suggested Citation

  • Alogoskoufis, Spyros & Langfield, Sam, 2019. "Regulating the doom loop," Working Paper Series 2313, European Central Bank.
  • Handle: RePEc:ecb:ecbwps:20192313
    Note: 1905193
    as

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    References listed on IDEAS

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    More about this item

    Keywords

    Bank regulation; sovereign risk; systemic risk;

    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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