Squaring the Eurozone’s Vicious Circle

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Over the last two years, European policymakers have been working to weaken banks’ grip on their sovereigns, introducing a Europe-wide supervisor and working toward a European resolution mechanism. But stabilizing eurozone financial markets also requires efforts in the other direction: mitigating sovereigns’ power over domestic banks.

SALAMANCA – The eurozone is caught in a diabolical loop, in which weak banking systems harm their sovereigns’ fiscal positions, which in turn compromise the banking system’s stability. But, over the last couple of years, policymakers have focused largely on reducing banks’ impact on their sovereigns – for example, through a Europe-wide supervisory authority and efforts to establish a European resolution mechanism – while ignoring the feedback in the other direction.

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