If government bonds were defined as the only high quality liquid assets, the link between banks and sovereigns would be reinforced, especially in the absence of risk weights for such bonds and if there are no diversification requirements. As central bankers, we are obviously in favour of prudent fiscal policies and a low level of public debt.
But the combination of the current low Danish public debt and liquidity regulation insisting on government bonds constituting a dominant large share of banks’ liquidity buffers would hurt liquidity in the Danish government bond market. The answer should obviously not be to increase public debt. The solution is not difficult.