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Sony Kapoor

Europe's Sovereign-Bank 'Doom Loop' Can't Be Broken

The European Union's effort to break the link between banks and government debt may make things worse.
Past panics are a distant memory.

Past panics are a distant memory.

Photographer: David Ramos/Bloomberg

Ever since the financial crisis, the European Union has grappled with how to solve the so-called sovereign bank doom loop -- the phenomenon whereby weak banks can destabilize governments that support them and over-indebted governments can push banks holding their bonds over the precipice. The widely touted solution is the European Banking Union, which the European Commission wants completed by 2018. New rules introduced European bank supervision, a new resolution framework that limits sovereign support and a pan-EU deposit insurance scheme as a means of breaking the interdependence between banks and sovereigns.

The first problem with this approach is that it's actually not possible to break the doom loop. The second is that trying to do so through the banking union may actually increase risks in the European Union.