This is what happened in Ireland, where the need to prop up the financial system pushed the public debt ratio up by nearly 30 percentage points. Conversely, weak government positions can destabilise banks – directly through their exposure to sovereign bonds, and indirectly through worsening macroeconomic conditions. This was the case in Greece. How can we break this “doom loop”?
The strengthened Basel III capital rules are a first step in that direction, as they increase capital buffers and thus the capacity of banks to absorb losses. The banking union, with its Single Supervisory Mechanism (SSM), is another such step. Strict and stringent supervision ensures that tough rules are applied equally to all.