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Regulating the doom loop

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  • Alogoskoufis, Spyros
  • Langfield, Sam

Abstract

Euro area governments have committed to break the doom loop between bank risk and sovereign risk. But policymakers have not reached consensus on whether and how to reform the regulatory treatment of banks’ sovereign exposures. To inform policy discussions, this paper simulates portfolio reallocations by euro area banks under scenarios for regulatory reform. Simulations highlight a tension in regulatory design between concentration and credit risk. An area-wide low-risk asset—created by pooling and tranching cross-border portfolios of government debt securities— would resolve this tension by expanding the portfolio opportunity set. Banks could therefore reinvest into an asset that has both low concentration and low credit risk. JEL Classification: G01, G11, G21, G28

Suggested Citation

  • Alogoskoufis, Spyros & Langfield, Sam, 2018. "Regulating the doom loop," ESRB Working Paper Series 74, European Systemic Risk Board.
  • Handle: RePEc:srk:srkwps:201874
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    Cited by:

    1. 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.
    2. 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.

    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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