by effect of contagion, even when fundamentals would not justify it. The high degree of financial integration within EMU means that, if left unchecked, contagion in the banking sector can spread rapidly via cross-border holdings of sovereign debt. For sovereigns themselves, sudden shifts in market re-pricing of risk can lead to unexpected liquidity challenges.
These dynamics underscore the importance of strengthening the mechanisms that prevent such risks – the SGP, surveillance of broader macroeconomic imbalances, and stronger financial supervision. However, the liquidity dry-outs and the contagion risks also call for stronger backstop mechanisms, to provide significant, albeit temporary, liquidity assistance. For the same reason, a permanent crisis management framework is appropriate for the euro area.