Regulating the doom loop
Spyros Alogoskoufis and
Sam Langfield ()
No 74, ESRB Working Paper Series from European Systemic Risk Board
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
Keywords: bank regulation; sovereign risk; systemic risk (search for similar items in EconPapers)
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Persistent link: https://EconPapers.repec.org/RePEc:srk:srkwps:201874
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