The sovereign debt strains in most advanced economies have focused attention on the treatment of sovereign risk in banking regulation and supervision. This speech highlights the recent rise in sovereign risk and the exposures of banks to some sovereigns as reflected in BIS data. Then it reviews recent criticisms of the supervisory treatment of sovereign risk. It argues that complacent pricing and accumulation of sovereign risk was largely a market outcome that should not be laid at Basel II's door. On the contrary, the treatment by large banks of sovereign credit as risk-free should be regarded as inconsistent with Basel II. Sovereigns should aim to restore their low-risk (if not risk-free) status in the bond market through fiscal reform and consolidation and banks' exposure to sovereign risk will need to be properly measured and covered by adequate capital.
Full speech, including charts (PDF, 16 pages, 643 kb)