(EU) Growing Risks: Government Bond Holdings Could Burden Banks

[unhappycamper]

http://www.spiegel.de/international/business/ecb-holds-back-controversal-bond-recommendations-a-935540.html



European banks hold increasingly large shares of government bonds as a result of the debt crisis. If those states default and can no longer service their debt, it could lead to massive losses. Germany's Bundesbank is pushing for new rules at the ECB.

Growing Risks: Government Bond Holdings Could Burden Banks
By Martin Hesse and Christoph Pauly
November 25, 2013 – 06:20 PM

The Bundesbank proposal is well-intentioned, but it has drawbacks: It puts cash-strapped banks and crisis-ridden states in a bind. And, perhaps more urgently, it creates a dilemma for the European Central Bank (ECB), which is set to evaluate the stability of the euro zone's largest banks. Before the ECB assumes its new supervisory authority over euro-area banks in 2014, it intends to review their balance sheets, weed out toxic assets and evaluate whether these institutions are adequately prepared to weather future market turbulence.

While the ECB wants to test the potential impact that losses from sovereign bonds would have on euro banks, there is debate over how rigorously sovereign holdings should be assessed. Weidmann's proposal, which could mean more banks would ultimately fail the tests, is likely to compound the challenges facing the ECB.

A team of 15 economic and financial advisers to the ECB's European Systematic Risk Board -- founded by the EU in late 2010 and tasked with recognizing and eliminating risks in the financial system -- were recently reminded of the politically sensitive nature of the topic of sovereign bonds. Doing their due diligence, the advisers had presented the board with recommendations on how to unravel the intricate ties between banks and sovereigns.

The experts came to the conclusion that when, for example, Spanish banks primarily hold Spanish sovereign bonds, and Irish financial institutions predominately hold Irish government bonds, this poses a risk that is comparable to when a bank grants a large proportion of its loans to a single company. To avoid such concentrations of risk, the advisers suggested that the banks be required to limit their sovereign bonds to a predetermined proportion of their investments. Another possibility would be to buttress these bonds with capital reserves, which would at least make it possible to adequately contain the risk over the medium term.