IGTA Journal - Winter 2020/2021

29/01/2021 The sovereign-bank-corporate nexus – virtuous or vicious? https://www.ecb.europa.eu/press/key/date/2021/html/ecb.sp210128~8f5dc86601.en.html 9/13 Source: ECB. Policy implications of the sovereign-bank-corporate nexus The extent to which these interlinkages may give rise to vulnerabilities in the future depends on two broad conditions. First, it depends on the effectiveness of the wide-ranging policy support that is currently in place. An accelerating pace of vaccinations, favourable financing conditions and significant pent-up demand in the form of large savings can prepare the ground for a strong rebound in economic activity in the second half of this year. This would relieve stretched corporate balance sheets. The responsible and timely use of funds provided under the Next Generation EU instrument, in combination with additional national investment efforts, can reinforce the cyclical recovery. It can bring the economy back to a higher sustainable growth path by accelerating structural change towards a more digital and less carbon-intensive economy. Higher and more sustainable economic growth will be the most important factor in ensuring that reinforced interlinkages will not give rise to vulnerabilities and risks in the future. Second, the potential materialisation of vulnerabilities will depend on the degree of divergence among euro area countries. Despite generally stronger interdependencies, the extent to which these might give rise to challenges in the future differs across the euro area. Banks in more highly indebted countries also tend to exhibit higher domestic sovereign exposures and higher corporate NPL ratios. To a large extent, this reflects unresolved legacy issues with respect to the banking sector and sovereign indebtedness ( Chart 9 ). Chart 9 Banks’ domestic government bond holdings and corporate NPL ratios across the euro area x-axis: percentage of total assets, y-axis: percentage of total corporate loans IGTA eJournal | Winter 2020/21 | 14