restore that government ’ s long - term solvency. the key factor here is that any resultant losses can also be borne by the bondholders without causing the financial system to collapse. in the eurosystem, these bondholders are frequently banks. if the sovereign - bank nexus is to be broken, the current preferential regulatory treatment of sovereign bonds should be ended at the earliest possible opportunity. not until banks have begun to hold sufficient capital against government bonds and the size of individual exposures has been made subject to limits will banks be able to effectively cope with the process of restructuring sovereign debt. and only then is there likely to be any concrete political will to take such action. bis central bankers ’ speeches 5. risk sharing economists like peter kenen 5 pointed out more than 40 years ago that a functioning monetary union was predicated on risk sharing between its constituent entities. the calls which i discussed just now for a lender of last resort to be introduced for sovereigns can be seen as just as much of a manifestation of these thoughts as the notion of introducing in the euro area a common unemployment insurance scheme, or, taken to the extreme, mutual liability in the form of euro bonds. but besides the problems i mentioned earlier which such a risk - sharing arrangement would cause in a monetary union and the question of striking the necessary balance between liability and control, i believe it would also be short - sighted to confine the risk - sharing debate to just the fiscal dimension. in the united states, for instance, researchers 6 have found that fiscal policy absorbs just 10 % to 20 % of economic shocks and thus prevents a local income shock from sparking a drop in consumption on the same scale. private forms of risk sharing play a much greater role. integrated capital markets smooth out cyclical fluctuations between the us states to a much greater extent – especially integrated equity markets, which cushion something like 40 % of volatility. if a business ’ s shareholder base is spread across many different states, so, too, will potential losses caused by a shock in that business ’ s home state ripple out beyond the confines of that particular region. hence, economic divergence between the individual us states is kept in check. in much the same way, the broad group of shareholders benefit from economic developments elsewhere in the united states when the economy is booming because their investment portfolios are more diversified. so business cycle divergence is kept in check in this direction, too. private risk sharing also manifests itself through loans taken out

bringing the entire financial system to its knees. or put differently : no bank should ever become so entangled in the rest of the financial system that its collapse would pull the whole web apart – banks should not be “ too big to fail ”. it is clear that the incentive problems i ’ ve just described would continue to exist if bail - outs were simply to be transferred from the central bank to fiscal policymakers. an example would be rescuing banks using taxpayers ’ money even though resolving them would be the wiser course of action. we cannot have governments providing free insurance, as such an implicit government subsidy makes banks too big and too risky. systemically important banks, in particular, therefore need to play a role in protecting themselves against default by increasing their equity capital and ensuring a minimum total loss - absorbing capacity ( tlac ) for their liabilities. by having banks bear the costs of their own protection, incentives are set for risk - conscious activities. banks simultaneously become more resilient, and the contagion effects are reduced should a bank run into difficulties all the same. we have seen some progress already with regard to equity capital. basel iii significantly strengthened the requirements for both the quantity and the quality of equity capital. however, to date, the binding rules have been based exclusively on risk - weighted capital. the risk weighting is supposed to prevent banks from investing too heavily in high - risk assets. during the financial crisis, however, we found out the hard way that the risk weighting does not always reflect the actual risk of an investment. therefore, in my opinion, a capital regime that is also geared to total assets is absolutely necessary. hence, the leverage ratio is to become part of pillar 1 of basel iii and thus binding from 2018. stricter capital requirements will help to increase the internal capital adequacy of banks. but capital does not come for free. this means that stricter requirements may also reduce the banks ’ readiness to take on any risks at all ; that is, to lend. but that would slow economic momentum. ultimately, this is also a balancing act. however, it seems clear that additional efforts to expand banks ’ capital base would be advisable, especially for systemically important banks and those that will just barely meet the basel iii requirements. but even stricter capital requirements cannot entirely prevent individual banks from collapsing. and this is okay. after all, the possibility of failure is essential in a market economy. this is why functioning resolution regimes are