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File photo. German finance minister Wolfgang Schaeuble said sovereign-debt risk is closely linked with the banking-union plan to tighten financial ties in the euro area. Photo: Reuters
File photo. German finance minister Wolfgang Schaeuble said sovereign-debt risk is closely linked with the banking-union plan to tighten financial ties in the euro area. Photo: Reuters

Sovereign-debt debate divides EU as Wolfgang Schaeuble pushes for limits

The EU faces a tough political battle over changes to the regulatory treatment of government bonds

Amsterdam: European Union finance ministers split over whether to impose restrictions on banks’ holdings of government bonds, as German finance minister Wolfgang Schaeuble found scant support from skeptical colleagues for his push to overhaul existing rules.

The Netherlands, which holds the EU’s rotating presidency, laid out five options for tackling the risks posed by banks’ state-debt pile for the bloc’s 28 finance ministers to discuss in Amsterdam on Friday. Schaeuble backed the Dutch initiative, while others, led by the Italian, Pier Carlo Padoan, warned that changes could destabilize the financial system and said the issue was too big for Europe to crack on its own.

“It’s no surprise that enthusiasm for the Dutch proposals varied in degree," Schaeuble told reporters on Saturday. “It’s also no surprise that we strongly backed the Dutch proposals."

The EU faces a tough political battle over changes to the regulatory treatment of government bonds. The issue has become a focus of political debate in recent months because of Germany’s insistence that the euro area should reduce the risks banks are facing, including government debt on their balance sheets, before creating a common deposit insurance system to round out the so-called banking union.

Concentration limits

The two main options on the table for dealing with sovereign bonds would be to impose limits on the concentration of debt that banks can hold, or to limit the current practice of treating many sovereign bonds as risk-free for regulatory reporting.

Schaeuble said sovereign-debt risk is closely linked with the banking-union plan to tighten financial ties in the euro area. He reiterated Germany’s insistence that EU countries need to finish implementing rules already on the books and make progress in de-risking banks’ balance books before talks can begin on any pooling of risk.

Support for the German’s position was muted at best.

“The most preferable option is the status quo," Padoan said, because this wouldn’t force banks to reshuffle their debt holdings, “creating the problem of where this debt will end up. This would provoke a readjustment shock in the market."

Like Padoan, French finance minister Michel Sapin said the sovereign-debt conundrum is a global issue best dealt with by the Basel Committee on Banking Supervision. That preference was also stated on Friday by Jonathan Hill, the EU’s financial-services commissioner.

‘Massive sell-off’

The conversation in Basel may not go smoothly, given the resistance to change from countries outside Europe as well as in the EU.

“It is clear that zero risk weights for all sovereign risk aren’t realistic," Nobuyuki Hirano, president of Mitsubishi UFJ Financial Group Inc., said earlier this month. “Changing the weight for sovereign risks will directly affect the portfolio management strategy of financial institutions, the main holder of sovereign debt in major countries."

Before taking any action, policy makers should “carefully consider various possible impacts including, assessment of alternative investors, and possible changes in demands," he said. “Regulation isn’t meant to raise risk weights for sovereign debts and lead to massive sell-off of sovereign bonds by financial institutions. No doubt that will lead to interest rate hikes, sovereign fiscal deterioration and suppression of economic growth in the world."

Stampede risk

In Europe, the issue is particularly important in Italy, where domestic state debt accounts for 10.5% of banks’ total assets, well above the euro-area average of 4.2%, according to European Central Bank data. In France and Germany, the figures are 2.3% and 3.2%, respectively.

Maltese finance minister Edward Scicluna said more study was needed on the potential impact of changing the rules on banks’ state-debt holdings before action is taken.

“Divesting banks so quickly from this could create a stampede," he said. “I told the meeting that in most cases more people tend to die in a stampede than from the actual fire when an alarm is raised. It becomes worse if the alarm is not a fire but the risk of an eventual fire." Bloomberg

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