Preparing for the Next Financial Crisis

Economic policies and nancial stability 273

and 3). Market speculation about the creditworthiness of some governments led

to increases in sovereign yields, mark- to- market losses on banks’ portfolios of

sovereign bonds, increases in their nancing costs and nally to higher interest

rates on loans to rms and households (Bank for International Settlements, 2011).

What are the drivers of banks’ domestic sovereign debt exposures?

− The literature focuses on banks’ risk- shifting incentives in their portfolio al-

location decisions. Banks prefer the risk prole of domestic sovereign bonds

because, as default risk increases, domestic bank equity holders can shift the

associated ex post losses to bank creditors (Acharya and Steen, 2015) or,