We propose a simple model of the sovereign-bank diabolic loop, and establish four results. First, the diabolic loop can be avoided by restricting banks' domestic sovereign exposures relative to their equity. Second, equity requirements can be lowered if banks only hold senior domestic sovereign...

We study the mechanisms through which the adoption of the Euro delayed, rather than advanced, economic reforms in the Euro zone periphery and led to the deterioration of important institutions in these countries. We show that the abandonment of the reform process and the institutional...