sets of players – banks and sovereigns – have one thing in common. they were only subject to the key market economy principle of liability to a very limited degree in the past. both were considered to be systemically important. it was feared that if they got into problems, this might jeopardise the stability of the financial system. in the end, it wasn ’ t the decision makers who were liable. but this is something that undermines the incentives for responsible behaviour. in the midst of the crisis, the weakness of one set of players then became that of the other. banks that had run into difficulties on account of distressed property loans in their books, say, had to be propped up by the taxpayer. the rescue sums required in countries like ireland, cyprus and spain were so huge that sovereign solvency, too, began to be called into question by investors. this drove refinancing costs higher. but the negative feedback loop also works in the opposite direction. ailing states can bring down banks that have substantial holdings of sovereign bonds in their books. it is this strong link between sovereigns and banks that needs to be severed. separating the two is all the more important because the nexus between banks and sovereigns actually even increased at times during the crisis. studies1 [ 1 ] suggest that it was notably the poorly capitalised banks in the crisis - hit states which took advantage of central bank refinancing to invest increasingly in high - yield domestic government bonds during the crisis. for when the insolvency of the home country is highly likely to bring down the institution in question as well, it can actually be quite rational to ramp up risk levels further still. after all, this barely increases the bank ’ s risk of insolvency but distinctly boosts the prospective profits if the outcome turns out to be favourable. v acharya and s steffen ( 2013 ), the “ greatest ” carry trade ever? understanding eurozone bank risks, working paper, nyu stern school of business. bis central bankers ’ speeches hence, this strategy further intensified the negative feedback loop between banks and sovereigns during the crisis. several incisions will be needed if we are to sever these links. the first of these will be the single supervisory mechanism, which is tasked with preventing banks from getting into difficulties at an early stage. but these are problems that cannot be entirely ruled out in the future, nor would we want to do so. after all, the possibility of failure

reduce or eliminate residual holdings, and that the timing and pace of any sales would be communicated to the public in advance. portfolio projections released in july 2017 do not include sales of any type over the forecast horizon. 9 statement regarding reinvestment in treasury securities and agency mortgage - backed securities, september 20, 2017. 10 logan, implementing monetary policy : perspective from the open market trading desk, may 18, 2017. 11 kandrac, the costs of quantitative easing : liquidity and market functioning effects of federal reserve mbs purchases ( 2014 ). 12 the treasury borrowing advisory council considered this topic in its third - quarter 2017 meeting, including the potential impact of changes in central bank policy abroad. see the august 1, 2017, presentation by tbac to the u. s. treasury. 13 in addition to these topics, we at the federal reserve are following closely the potential for the decline in the balance sheet to affect other aspects of the structure of financial markets or the banking industry. as one example, we are paying attention to the possibility that a decline in the size of the balance sheet puts downward pressure on bank deposits. as discussed earlier, in general, balance sheet normalization removes an asset from the private sector that can be held only by banks ( reserves ) and replaces it with an asset that can be held by anyone ( securities ). it is possible that, on net in equilibrium relative to a counterfactual in which the balance sheet does not decline, ( a ) banks will hold fewer reserves ; ( b ) banks will offset some of this decline by holding securities instead, and some by taking in fewer deposits ; and ( c ) non - banks will replace those deposits with securities. the extent ( if any ) of any such decline in deposit activity on deposit and loan pricing will likely depend on a variety of factors, including the extent to which the decline comes from wholesale institutional deposit activity motivated by interest rate arbitrage. see ihrig, mize, and weinbach, how does the fed adjust its securities holdings and who is affected?, september 22, 2017 7 / 7 bis central bankers'speeches