Financial-sovereign linkages have been an important motivation for many crisis interventions in Europe. The European Central Bank’s two targeted longer-term refinancing operations, its Outright Monetary Transactions programme, the European Banking Union, the Single Supervisory Mechanism, the European Stability Mechanism, the Single Resolution Mechanism and the Bank Recovery and Resolution Directive — were all effectively created to address the bank-sovereign nexus.
The past few weeks have demonstrated their limitations. Critics point to an inexorable rise in funding costs for the Italian banking sector caused by the relentless march higher of BTP yields, caused in turn by a sovereign making profligate promises. From Turkey they see European banks — BBVA, BNP Paribas and UniCredit — underperforming in debt and equity as a result of subsidiaries with heavy exposure to local assets.
But the fortunes of banks are always going to ebb and flow on the economic tides of the countries in which they operate.
The OMT programme is designed to put a lid on credit spreads and keep sovereigns liquid in a crisis — which should ensure that the economy does not crash, bringing with it an explosion of non-performing loans that takes down the banks.
From the other side, the SRM and the BRRD are designed to safely euthanize troubled banks — which should ensure that sovereign cash does not need to follow a failing bank into a hole in the ground.
Neither policy should or could decouple sovereigns from banks. They are closely linked and always will be, but just don’t call it a doom loop.