Spillover Effect

Spillover effects are the subsidiary or follow-on impacts in one area from events in another. In today’s globally interconnected financial world, spillover effects are an ever-present possibility and policymakers and regulators go to great lengths to minimise the impacts of spillover effects, when negative. The so-called bank-sovereign doom loop is an example of a situation with two-way spillover effects: distressed banks can be a severe strain on governments with weak public finances, particularly if they require government support; while sovereigns suffering budget crises and rapidly rising government bond yields are a severe strain on the solvency of domestic banks, which typically have large holdings of their government’s bonds.