Diabolic Loop, A major problem in International Banking

One Major problem in International Banking is Diabolic Loop. Some banks a very significant investment in domestic government bonds and Economic Slowdown in that Countries.

There is a major problem in International Banking Sector, which is called the Diabolic Loop. Some banks a very significant investment in domestic government bonds and economic slowdown in countries just like Greece or Italy, increasing sovereign risk, reducing the value of the bonds held by banks. due to reduced solvency.

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. The “diabolic loop” between the credit risk of sovereigns which of banks was an indicator of the crisis. within the American Economic Review: Papers and Proceedings, a straightforward model of this sovereign-bank diabolic loop, and show that it are often avoided by restricting banks’ domestic sovereign exposures relative to their equity.

Furthermore, we show that equity requirements may be reduced if banks only hold the senior tranche of an internationally diversified sovereign portfolio—known as ESBies (European Safe Bonds) within the euro-area context.

Nowadays, the Distress of Bank Industry increased the possibilities that banks would have to be compelled to be bailed out by their Domestic Government, which increased sovereign distress even further, engendering a “bailout-loop”. Moreover, the recessionary impact of the liquidity crisis led to a discount in tax income, which also lead to weaken the government solvency in these countries, triggering a “real-economy loop”.

There are three ingredients to the feedback loops.

1- First, the debt portfolio among the house of Banks’ Bias leads to sovereign debt portfolios, and their Equity Value and Solvency hooked into swings within in order to be perceived solvency and market price of their own government’s debt.

2- Second, the lack of governments, to take action for committing ex-ante, to not bail out domestic banks, since bailout is perfect once banks are distressed.

3- The third ingredient to the feedback loop is that, in which Mobility of Free Capital in the economy, which will ensure to international investors, to take pre-emptive of government solvency in the future.

Whether warranted by fiscal fundamentals or not – are incorporated within the market price of domestic government debt. to interrupt these loops, the policy must remove a minimum of one among these three ingredients. So far, capital controls are the sole policy remedy adopted in response to the diabolic loop, in Cyprus and Greece. for the intention to eliminate the diabolic loop by reducing the sensitivity of banks’ sovereign debt portfolios to domestic sovereign risk.

These International banks cut back on lending triggering a reduction in economic activity and tax revenues. So the who is the linkage between government to banking? and then back to the government and potentially creating a major financial crisis in the country.

So it is a very important question is why is it that banks are buying so much of their domestic country bonds? I've been talking myself to chief risk officer or banks, and every time I asked them, Why do you buy so much of your local domestic bonds? And the answer is always the same because they have a higher return.

And therefore, indeed, it's unfair gambling because they shareholders will get a high interest on the bounce if things go well, and the things go poorly, losses will be better by government or eventually the IMF of the European Union.

There are three proposed ways to deal with this problem.

1-  One way is to come up with implement, New Regulations to Limit the Possession of Government Bonds.

2-  The second proposal, instead of having a bank, only local government bonds, they will invest in a portfolio of bonds of different countries, describe as Widen Bond Investments to different Markets.

3-  The third option, which I prefer is to decide to cut completely the linkage between the State and the Banks. We make banking a normal industry. You take risks. Well, you bear the cost. When I say you, these are the shareholders, the bondholders, the creditors, with the idea is to cut the link between the government and the banks, simply describe as Cut the link between governments and banks, and normalize the banking industry.

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Beyond Narrative | Blog Where Every Single Word Matters: Diabolic Loop, A major problem in International Banking
Diabolic Loop, A major problem in International Banking
One Major problem in International Banking is Diabolic Loop. Some banks a very significant investment in domestic government bonds and Economic Slowdown in that Countries.
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