While bank exposures to a single counterparty are limited, in principle, to a quarter of their eligible capital, exposures to sovereigns are exempted from that large exposures regime. Thus, many European banks hold bonds from one sovereign only – their home country. But a high level of undiversified sovereign exposure is what makes sovereign default a potentially systemic event.
For this reason, the large exposures regime needs to apply to sovereigns as well. Moreover, sovereign exposures are privileged by low or zero capital requirements. An adequate risk-weighting of sovereign bonds would make banks more resilient if the fiscal position of the respective sovereign were to deteriorate.