to touch upon. currently, the proposal to end the preferential treatment of sovereign debt is being dealt with in the same way as physical exercise is. everybody agrees it ’ s a good thing in theory. but in practice, it ’ s very hard to get off the couch. hence, as of now, sovereign debt denominated in an advanced country ’ s own currency is still considered risk - free. daniele nouy recently grasped the nettle and pointed out : “ sovereigns are not risk - free assets. that has been demonstrated, so now we have to react. ” i wholeheartedly concur and have repeatedly asked to put this issue on the regulatory agenda. sovereign debt needs to be backed by capital, and exposure to a single sovereign must be capped, just as is the case for any private debtor. i welcome that the regulatory treatment of sovereign debt is now being discussed by the basel committee. but if these discussions fail to produce an agreement, we need to move forward with a european solution. in contrast to other jurisdictions, the eurosystem is for good reasons forbidden to act as lender of last resort for governments. the risk profile of euro - area sovereign debt is therefore different. 4. the tax deductibility of interest as benjamin franklin famously said, nothing is certain except death and taxes. but actually, this timeless quip does not apply to debt. interest expenses are tax - deductible, while equity disbursements are not. bis central bankers ’ speeches how sensitive are banks to this difference in tax treatment? a study 5 by imf economists suggests that they are as sensitive as any other firm. what does this imply for the leverage of banks? the imf economists estimate that abolishing the preferential tax treatment of debt would raise average unweighted bank equity by 2. 2 to 4. 2 percentage points. even though the authors caution that the effect is likely to be lower for the biggest banks, these numbers are sizable by any measure, especially considering that the proposed basel iii leverage ratio is 3 %. doing away with the preferential tax treatment of debt could therefore provide a major boon for financial stability. 5. conclusion ladies and gentlemen, debt is like oxygen : indispensable for economic life, but when you overdose on it, you first get high, and then you faint. air quality regulation has made great strides over the last decades, at least in the advanced countries. i hope we can replicate

to be determined by market forces. it is therefore all the more important that this market process functions as efficiently as possible. and this is where the regulators come in. it is our job to make sure that the regulatory treatment of debt does not give rise to incentives that endanger financial stability. and it is our job to make sure that, if things still go wrong, the financial sector can still deliver its important services to the real economy. as the financial crisis and the euro - area sovereign debt crisis have shown, there is ample room for improvement here. in particular, we need to ensure that all actors bear the responsibility for their respective decisions. to me, three issues are of special relevance in this regard : the question of bail - in vs. bail - out, the regulatory treatment of sovereign debt, and the tax preference of debt over equity. 2. bail - in vs. bail - out let me start with a question that has been debated heatedly since the crisis broke out : the issue of bail - in vs. bail - out. the financial sector is unique in that a malfunctioning of this sector impairs the functioning of all other sectors of the economy. and the crisis has served as a stark reminder that a malfunctioning cannot be ruled out. some form of protection is therefore called for – otherwise, innocent bystanders in the real economy will inevitably get hurt. depending on the kind of malfunctioning, the central bank might be able to provide the protection. if the issue is a temporary dry - up of liquidity, it can act as a lender of last resort and supply the necessary funding – on an interim basis. but if the issue is one of solvency, then the central bank has no role to play, as taxpayers ’ money might be ultimately at stake. rather, it is then for politicians to decide whether to let a bank fail or not. providing insurance in the form of a bail - out comes with obvious moral hazard problems. if banks know that they are too big to fail, they are tempted to make the most of this insurance and take on excessive risks, at the expense of society at large. as the bank of england ’ s chief economist andy haldane put it : “ only in banking do control rights and incentive wrongs combine so uncomfortably. ” instead of the public providing cost - free insurance for banks, the onus is on banks to insure themselves against failure. only then are risk and reward