In this paper I investigate the relationship between the sovereign debt crisis and the credit crunch in Europe. Using data from the European Banking Authority (EBA) on banks’ exposure to government debt, I construct a bank–specific shock which measures the impact of the sovereign debt crisis on each bank’s balance sheet. I show that banks more exposed to the sovereign shock tightened credit supply by more than banks that were less exposed. Controlling for aggregate credit demand conditions at the country level, a 1% increase in the sovereign losses-over-total assets ratio leads to a decline in the growth rate of both domestic and foreign loans around 4%. The results are also robust to instrumenting the sovereign exposure with banks’ government ownership. Moreover, using syndicated loans data, I show that interest rate spreads are around 2% higher for the same firm borrowing from syndicate of banks with different level of sovereign exposures. The data suggest that banks’ sovereign exposures mattered for the credit crunch because they increased banks’ cost of funding rather than affecting banks’ regulatory capital.