The emergence of a vicious circle between the health of a sovereign’s finances and that of its banks threatens the eurozone’s stability.
If markets’ fears of haircuts on sovereign debt wipe out banks’ capital buffers, then that would necessitate a recapitalisation. But a recapitalisation could, in turn, push states’ debt-to-GDP ratios above levels investors consider sustainable.
But, luckily, research which appeared on VoxEU.org on Sunday, based on a paper published by the think tank Bruegel earlier this month, indicates that, at present, the problem is confined to Greece.
Policymakers should be relieved. However, that the problem can be observed in Greece’s case highlights just how essential it is for the eurozone authorities to avoid any talk of haircuts for the likes of Italy.