Sovereigns likewise benefit over the short term since they can easily obtain funding through the artificially inflated demand for government bonds – yet at the same time this lessens the pressure to reform, to consolidate government finances and achieve debt levels which are sustainable over the long term. The crisis showed more than clearly that even euro-area government bonds may be exposed to risk.
This is why, in my view, risk-based capital requirements need to be extended to cover banks’ on-balance-sheet lending to sovereigns. I also believe it still makes sense to limit banks’ exposures to individual sovereigns – much like the large exposure limits for private-sector borrowers. That way, even if these borrowers were to default, banks would still have enough capital at their disposal.