debt was risk - free, triggering a rapid repricing of sovereign risk. to those who saw the crisis as a consequence of moral hazard, this represented a required return of market discipline vis - a - vis sovereigns – a view that was reflected in the deauville agreement in october 2010. 1 / 9 bis central bankers'speeches these events spread contagion to all sovereigns now perceived as vulnerable by financial markets. but they affected most of all those with high public debt levels, a lack of fiscal space, fragile market access and, especially, low growth. sovereign risk was then transmitted into the domestic banking sector through two channels. the first was through banks ’ direct exposures to their own governments ’ bonds. between january 2010 and july 2012, banks in greece, italy and portugal incurred aggregate losses on sovereign bonds of vulnerable countries2 amounting respectively to 161 %, 22 % and 36 % of their core tier 1 capital. 3 regardless of whether these losses directly affected regulatory capital4, they had an adverse effect on perceptions of solvency in those national banking systems. the second channel was via negative confidence effects. because the public sector makes up roughly half the economy in many euro area countries, and because of credit rating dynamics, the fear of possible sovereign defaults had a dramatic effect on confidence in the domestic private sector. any distinction between firms and banks, and between banks with and without high sovereign exposures, disappeared. the general loss of confidence in these countries ’ prospects reverberated through the banking sector via a further fall in growth. 5 in this way, the crisis spread to banks that did not have significant exposures either to us subprime assets or to domestic real estate, and therefore had not until then needed to be bailed out. however, governments in these countries found themselves unable to substantially respond to the emerging crisis with public money for the banking sector and countercyclical fiscal policy, due to lack of fiscal space and high debt. financial markets then began to fragment along national lines and cross - border funding dried up, exacerbated by defensive risk management by banks and ring - fencing of liquidity by supervisors in the core countries. lack of liquidity, coupled with capital depletion from domestic losses, precipitated a renewed credit crunch. countries were trapped in a “ bad equilibrium ” caused by the three - way link between sovereigns, banks and domestic firms and households. falling credit aggravated the ongoing recession, increased loan losses and further

integration and risk sharing in a monetary union ”, financial integration in europe, may. 13 asdrubali et al. find that financial risk - sharing in the united states increased monotonically each decade from the 1960s to the 1990s. see asdrubali, p., sorensen, b. and yosha, o., “ channels of interstate risk sharing : united states 1963 – 1990 ”, the quarterly journal of economics, vol. 111, issue 4, 1 november 1996. 14 see hane, g. ( 1998 ), “ the banking crises of the 1980s and early 1990s : summary and implications ”, in fdic banking review, vol. 11, no 1. 15 ecb calculations based on fdic data. the term “ institution ” refers to a separately chartered commercial bank or savings institution. 16 see krozner, r. and strahan, p. ( 2014 ), “ regulation and deregulation of the u. s. banking industry : causes, consequences, and implications for the future ", in economic regulation and its reform : what have we learned?, national bureau of economic research. 17 see morgan, p., rime, b. and strahan, p. ( 2004 ), “ bank integration and state business cycles ”, the quarterly journal of economics, vol. 119, issue 4, 18 european commission estimates. see nikolov, p. ( 2016 ), op. cit. 19 see milano, v. and reichlin, p. ( 2017 ), “ risk - sharing across the us and emu : the role of public institutions ”, policy brief, luiss school of political economy. 20 tier 1 capital to total assets. 21 ecb ( 2018 ), “ box a : what could enhance private financial risk sharing in the euro area? ”, financial integration in europe. 22 for a more detailed explanation, see ecb ( 2017 ), “ special feature : cross - border bank consolidation in the euro area ”, in financial integration in europe. 23 see carmassi, j. et al. ( 2018 ), “ completing the banking union with a european deposit insurance scheme : who is afraid of cross - subsidisation? ”, occasional paper series, no 208, ecb. 24 this includes guaranteeing the assets or the liabilities of the institution under resolution ; making loans to or purchasing assets from the institution under resolution ; and making contributions to a bridge institution