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 11/13 Sources: European Commission (AMECO database) and ECB calculations. Notes: Countries are split into highly and less highly indebted based on the median debt-to-GDP ratio of 13 sovereigns in 2019 for which data on the NFC gross operating surplus are available. Highly indebted (above median): ES, FR, BE, PT, IT, GR. Less highly indebted (below/equal to median): EE, NL, IE, FI, DE, SI, AT. This underlines the importance of support at the European level. The Next Generation EU instrument helps alleviate potential strains on national fiscal space, thereby partly decoupling corporate financing conditions from the fiscal space of their respective sovereigns and directly attenuating the sovereign- bank-corporate nexus. At the same time, these vulnerabilities are a reminder of the urgent need to make further progress on reforming the euro area’s institutional architecture, in particular by completing the Banking Union, advancing the Capital Markets Union and reviewing the European fiscal framework. These reforms will foster risk sharing, enhance resilience and reduce procyclicality. From the viewpoint of monetary policy, the potential emergence of an adverse macro-financial feedback loop between sovereigns, banks and corporates would matter for at least two reasons. First, it could measurably slow down the return of inflation to our medium-term aim. Increasing corporate defaults through a premature withdrawal of fiscal support would deepen the contraction in output and, ultimately, exert additional disinflationary pressures. Second, there is a risk that the sovereign-bank-corporate nexus could impair the smooth transmission of monetary policy through financial instabilities, a credit crunch and self-fulfilling price spirals. The risk of a premature phasing out of fiscal support is largely outside the ECB’s control. But governments need to be mindful of cliff effects that might set off a vicious circle of corporate defaults, tighter bank lending conditions and growing sovereign vulnerabilities. IGTA eJournal | Winter 2020/21 | 16