A crucial tool of risk management is diversification. A cap on loans to an individual sovereign should therefore also be introduced. A large exposure regime of this kind was already introduced for loans to the private sector some time ago. Large exposure caps prevent banks from becoming overexposed to a single borrower.
This makes them less vulnerable to the default of that borrower – and this is needed not just for private borrowers but for government borrowers as well. The Basel Committee on Banking Supervision started its work on sovereign bonds last December. I believe the following points are crucial and need to be addressed within the next few months.