This paper analyses whether the introduction of capital requirements for bank government bond holdings increases nancial stability by making the banking sector more resilient to sovereign debt crises. Using a theoretical model, we show that a sudden increase
in sovereign default risk may lead to liquidity issues in the banking sector. Our model reveals that in combination with a central bank acting as a lender of last resort, capital requirements for government bonds increase the shock-absorbing capacity of the banking sector and thus the nancial stability. The driving force is a regulation-induced change in bank investment behaviour.