Sovereign Creditworthiness and Financial Stability: An International Perspective
Financial stability depends critically on the two-way interaction between banks and governments. Sovereign creditworthiness represents the ultimate source of insurance for the ﬁ nancial system and provides a solid basis for the pricing of assets, by supplying a risk-free security. A sound banking sector ensures the smooth ﬂ ow of credit to the economy as well as solid revenue and ﬁ nancing for the government. Weakness in either sector can give rise to a vicious circle of uncertainty and distress with highly damaging consequences for the economy. An interconnected global economy means that problems can propagate across borders. The policy recommendation is simple: appropriate buffers should be built in good times to cushion the impact of bad times. Fiscal buffers support the risk-free status of sovereign debt, while capital and liquidity buffers underpin the soundness of the ﬁ nancial system.