The relationship between banks and the state in the context of the European debt crisis

The euro area has developed relatively intensively since the sovereign debt crisis, in terms of regulation, supervision and institutional arrangement, both in the financial sector and in the fiscal domain. This development was a response to the instability caused, among other specific conditions prevailing in the euro area, by the interconnection of the default risks of banks and sovereigns, the so-called sovereign-bank nexus. This led to a crisis cycle, in which the deteriorating situation of banks undermined the sustainability of government public finances, while growing caution about sovereign issuers created losses on the banks' balance sheets, increasing the need for state aid to banks and closing the loop that fueled the crisis. A partial goal of strengthening the resilience of the economic and monetary union, the weaknesses of which were revealed by the effects of the crisis, was to reduce the potential of risk-transfer between sovereigns and banking sectors, so as not to strengthen the crisis spiral and deepen cyclical, otherwise standard crises. In this work, it is examined how the intensity of the negative feedback loop between banks and sovereigns has evolved in the decade since the crisis and whether, over time, as reforms in banking and fiscal policy coordination proceeded, the intertwined risk has decoupled. To this end, the development of sovereign exposures in the euro area and, in particular, the problem of the increased tendency of banks in the euro area to hold primarily domestic sovereign bonds, the so-called home bias, were analyzed. Furthermore, a correlation analysis of the development of spreads on credit default swaps (CDS) of banks and euro area countries was used. The results of the analysis show that if the euro area is considered as one jurisdiction, the relationship between the "European sovereign" and the banks is statistically less and less significant, and the sovereign-bank nexus has gradually weakened since the peak of the debt crisis. However, if individual euro area countries are measured in relation to the banks on their territory, sovereign-bank nexus still proves to be very strong, and only in a few countries the nexus has gradually weakened, although staying still at high levels. As sovereign-bank nexus is a problem primarily at the national level, it can be stated that the identified problem was not solved during the ten years since the outbreak of the crisis. Sovereign-bank nexus is likely to continue to be maintained due to insufficient or non-existent treatment of the main direct channels of risk transfer at domestic level, from banks to the state through national deposit insurance and from the state to banks through domestic sovereign exposures. It is also possible that the mechanisms by which some risk transfer channels have already been addressed, such as the incomplete banking union or ineffective fiscal surveillance framework, lack the needed credibility. The euro area should thus focus, first, on streamlining the current framework and strengthening its credibility, in particular by addressing shortcomings in the application of the existing rules and their poor enforcement (whether in the area of bank crisis management or fiscal discipline). Second, the euro area should introduce reforms to address the remaining channels of risk transfer between the member states and the domestic banking sectors. Both existing and as yet unimplemented reform measures aimed at dismantling sovereign-bank nexus are analyzed in this work. But the mere completion of projects currently envisaged by the euro area may not be sufficient to weaken the crisis loop potential, as they represent a rather minimalist vision given the current political limits.