Blog Post

Chart of the week: a deadly embrace

Europe is determined to break the vicious circle between sovereigns and banks. To achieve this aim, it appears to be clear that Europe will need a strong central supervisor, a common resolution authority as well as the appropriate fiscal backstop to help in case of major crisis when the resources of the resolution fund are […]

By: Date: December 4, 2012

Europe is determined to break the vicious circle between sovereigns and banks. To achieve this aim, it appears to be clear that Europe will need a strong central supervisor, a common resolution authority as well as the appropriate fiscal backstop to help in case of major crisis when the resources of the resolution fund are exhausted. As Europe is advancing its work on the banking union, the increased dependence of banks on their sovereigns in the last year has not received sufficient attention.

An important reason for the link between banks and sovereigns is the fact that banks are holding government bonds on their books. Already before the crisis, European banks were holding large amounts of sovereign debt on their books. Total sovereign bond holdings amounted to around 1200 billion euro at the end of 2007 for all banks in the euro area. This made the resolution of the crisis so difficult. Any doubt about the solvency of governments translated into doubt of the banking system.

The deadly embrace between banks and sovereigns has accelerated at a rapid pace since then. Euro area banks are now holding more than 1600 billion euro of government securities on their books. Even more worrying than the absolute numbers is the increase of government debt on the books of banks located in Southern Europe. While banks in the north of Europe have increased sovereign bond holdings by only 5% since the end of 2007, banks in the South of Europe have doubled their bond holding. Banks located in Greece, Spain, Italy, Portugal and Ireland now hold more than 700 billion of sovereign debt on their books while in 2007 it was around 350 billion. In Spain, the number almost tripled. The  government  bond  holdings  of Italian, Portuguese and Spanish banks have in particular increased, by €180 billion, €30 billion and €160 billion respectively. Banks started financing governments in the 2009 when large deficits emerged in the South of Europe. During 2012, cheap ECB liquidity permitted banks in the South to buy government bonds yielding a handsome margin. The graph is showing the dramatic increase in bond holdings in the course of this year.

What does this deadly embrace mean for Europe’s banking union? The Bundesbank president Jens Weidmann has drawn his conclusion and asked for the introduction of risk weights to sovereign debt. That would require banks to hold significantly more capital for sovereign debt of Southern European countries. This proposal in principle makes sense. To break the link between banks and sovereigns would ideally mean a banking system with little sovereign debt on its books. However, the problem with this proposal is that it comes 5 years too late. Introducing such risk weights now would increase the cost of sovereign debt in the South of Europe significantly. This in turn would increase the likelihood of sovereign debt restructuring. Unfortunately, the deadly embrace has increased so much in particular in the last yeat that a sovereign debt restructuring would have incalculable consequences for the euro area financial system. If at all, such a proposal could only be implemented in a couple of years when doubts about solvency have already been overcome.

In the meantime, it however appears that sovereign debt restructuring is actually becoming less likely and more mutulisation is possible. Even if sovereign debt was unsustainable now, a debt restructuring would have more negative and incalculable consequences on the banking system now than 5 years ago. Even a strong bank restructuring regime would not be able to impose losses of a sovereign insolvency on bank creditors on such a scale. There would have to be support coming from the fiscal backstop to the resolution fund. In a sense, Europe will have the choice of rescuing its governments or rescuing its banks. The deadly embrace may therefore push Europe towards more mutualisation of risk now. Only in the long-run, a system with less mutualisation and less government debt in the banking system remains still possible.

Topics

Comments

Read article More on this topic More by this author

Blog Post

Jérémie Cohen-Setton

The history of the macroeconomic divide

What’s at stake: Following up on his mathiness critique that economic theory is becoming a sloppy mixture of words and symbols, Paul Romer wrote a series of blog posts over the past few weeks discussing how things went so far off in the macroeconomic field, where a group (often referred as fresh-water economists) completely retreated from scientific engagement with macroeconomists who disagreed with them and gave up on using evidence to evaluate models.

By: Jérémie Cohen-Setton Topic: European Macroeconomics & Governance Date: August 24, 2015
Read article More on this topic More by this author

Blog Post

Silvia Merler

Greece budget update - August

The Greek finance ministry published last week the latest budget execution bulletin. The state budget primary balance increased significantly during July. Greece recorded a primary surplus of 1.6 billion euros in July, which takes the cumulated primary surplus for the first six months of the year at 3.5 billion euros, against a primary surplus target of 2.99 billion euros. This is the highest monthly value for the primary surplus since August 2014.

By: Silvia Merler Topic: European Macroeconomics & Governance Date: August 17, 2015
Read article More on this topic More by this author

Opinion

Guntram B. Wolff

Greece: Lessons for Europe

It was inevitable that Greece would have to make cuts. Yet, if it is ever to pay back its debts, what the country needs most of all is a growth strategy.

By: Guntram B. Wolff Topic: European Macroeconomics & Governance Date: August 13, 2015
Read article More on this topic More by this author

Opinion

Grégory Claeys

Los trémulos cimientos del 'plan Juncker'

Los detalles del plan alimentan el escepticismo

By: Grégory Claeys Topic: European Macroeconomics & Governance Date: August 7, 2015
Read article More on this topic More by this author

Blog Post

Ashoka Mody

Wolfgang Schäuble, Debt Relief, and the Future of the Eurozone

The German Finance Minister Wolfgang Schäuble has had enough. Greece, he says, cannot receive debt relief from European creditors because European official creditors are forbidden by European treaties to grant relief. But this cannot be true. Once a loan has been made, any lender exposes himself to a default risk.

By: Ashoka Mody Topic: European Macroeconomics & Governance Date: August 6, 2015
Read article More on this topic

Opinion

Guntram B. Wolff

Greece’s debt burden can and must be lightened within the Euro

The current link between debt servicing and membership of the single currency leads to a vicious circle that increases uncertainty, weakens growth and makes full debt repayment less likely. There will be no confidence and no growth in Greece without a solution to the debt problem.

By: Armin von Bogdandy, Marcel Fratzscher and Guntram B. Wolff Topic: European Macroeconomics & Governance Date: August 5, 2015
Read article More on this topic More by this author

Blog Post

Silvia Merler

Now you see it, now you don’t

The first Italian case of bail-in.

By: Silvia Merler Topic: European Macroeconomics & Governance Date: August 3, 2015
Read article Download PDF More on this topic More by this author

Policy Contribution

Reform momentum and its impact on Greek growth

Reform momentum and its impact on Greek growth

The time is ripe to analyse in fine detail the conditions attached to the Greek programmes and to look in particular at the degree of structural reform implementation under the first and second programmes, the speed at which implementation took place, and the headings under which reforms were enacted, especially compared to the other euro-area programme countries.

By: Alessio Terzi Topic: European Macroeconomics & Governance Date: July 29, 2015
Read article More on this topic More by this author

Video

Video

Competitive gains in the Economic and Monetary Union

This event was organised in the frame of the 10th Anniversary of Bruegel. It brought together a panel of high level economic experts to discuss the competitive gains achievable through reinforcing the Internal Market and structural reforms.

By: Bruegel Topic: European Macroeconomics & Governance Date: July 22, 2015
Read article More on this topic

Opinion

Guntram B. Wolff

Griechenlands Schuldenlast kann und muss im Euroraum erleichtert werden

Die Verknüpfung von Schuldendienst mit der Mitgliedschaft in der Währungsunion führt zu einem Teufelskreis, der das Wachstum schwächt und damit eine Rückzahlung der Schulden unwahrscheinlicher macht. Wir schlagen vor, den Teufelskreis durch eine Bindung der Kreditzinsen an das Wachstum der griechischen Wirtschaft zu durchbrechen. Ein Griechenland ohne Wachstum soll keine Zinsen und keine Tilgung zahlen. Je stärker das Wachstum, desto höher die Zinsen und Rückzahlungen an die europäischen Gläubiger. 

By: Armin von Bogdandy, Marcel Fratzscher and Guntram B. Wolff Topic: European Macroeconomics & Governance Date: July 22, 2015
Read article More on this topic More by this author

Blog Post

Jérémie Cohen-Setton

Understanding the Neo-Fisherite rebellion

The idea that low interest rates are deflationary – that we’ve had the sign on monetary policy wrong! – started as a fringe theory on the corners of the blogosphere 3 years ago. Michael Woodford has now confirmed that modern theory, indeed, implies the Neo-Fisherian view when people’s expectations are infinitely rational.

By: Jérémie Cohen-Setton Topic: European Macroeconomics & Governance Date: July 19, 2015
Read article More on this topic More by this author

Blog Post

Silvia Merler

Greece budget update

Primary surplus picked up in June, but July is the key month to watch.

By: Silvia Merler Topic: European Macroeconomics & Governance Date: July 16, 2015
Load more posts