September 2020 issue contents
Regulating the Doom Loop

Spyros Alogoskoufis and Sam Langfield
European Central Bank


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.

JEL Code: G01, G11, G21, G28.

Full article (PDF, 42 pages, 10206 kb)
Online appendix