They are interrelated because banks hold a large quantity of their own government’s debt in many countries. Unsustainable public finances have a direct impact on the rating of sovereign bonds and thus on banks’ balance sheets. As a consequence, waning market confidence, losses and strained funding conditions can be detrimental to the resilience of the financial system as a whole.
Fiscal policy can also impact on financial stability through tax incentives. Just think of the role that tax incentives play in the overheating of real estate markets, for example by promoting owner-occupied housing through overly generous tax deductions for mortgage lending rates. Or think of the widespread preferential treatment of debt over equity.