Sovereign debt crises have been recurrent events over the past two centuries. In recent years, the
timing of sovereign crises has coincided or has directly followed banking crises. The link
between sovereigns and banks tightened as the contingent liability that the banking sector
represents for the sovereign grew, as financial “safety nets” became more common. This chapter
analyzes the transmission channels between sovereigns and banks, with a focus on the effect of
sovereign distress on bank solvency and financing. It then highlights the notable cost to the real
economy of the close connection between sovereigns and banks. Breaking the “feedback loop”
between these two sectors should be an important policy priority.