The sovereign bank link and the imperative to break it is fairly ubiquitiuous in today's discussion how to improve the financial system. Like with so many overused and underthought buzz words, the sovereign bank link embeds several aspects which circumscribe different problems and solicit different solutions:
Banks' preference for public over private lending: Public sector loans and sovereign bonds often enjoy privileged treatment, such as zero risk weight among other. This is often thought to bias banks towards lending to the public sector. However, competition will cause this benefit to accrue to the debtor, not the creditor: all else equal, the cost of funds for the public debtor becomes cheaper than for private debtors, resulting in a lower hurdle rate for public than for private investments. This can lead to an unhealthy allocation of savings indeed....
