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.