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 European Macroeconomics & Governance Tags & Topics

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.


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

View comments
Read article Download PDF More by this author

Working Paper

Cover WP 2017_06

Regional and global financial safety nets: the recent European experience and its implications for regional cooperation in Asia

Comparing and evaluating financial assistance programmes of four euro-area countries (Greece, Ireland, Portugal, and Cyprus) and three non-euro-area countries (Hungary, Latvia, and Romania) of the European Union in the aftermath of the 2007/08 global financial and economic crisis. Asian countries can draw several lessons from European experiences.

By: Zsolt Darvas Topic: European Macroeconomics & Governance, Finance & Financial Regulation, Global Economics & Governance Date: April 20, 2017
Read article More on this topic More by this author

Podcast

Podcast

Labour mobility in Europe

With anti-immigration sentiment on the rise, we look into the issue of labour mobility in Europe. How does migration affect labour markets and how does perception of migration differ from reality? What are the economic challenges for migrants and how do these challenges reflect on social integration? We try to answer these questions with our guests in this episode of The Sound of Economics.

By: The Sound of Economics Topic: European Macroeconomics & Governance Date: April 20, 2017
Read about event More on this topic

Past Event

Past Event

Understanding the French elections

This is a restricted workshop on the forthcoming French elections to understand the challenges and possible scenarios.

Speakers: Grégory Claeys, Thomas Guénolé-Ryzhakov, Bruno Jeanbart and Guillaume Tusseau Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: April 19, 2017
Read about event

Upcoming Event

May
30
11:00

Geo-blocking in the digital single market

Geo-blocking is a discriminatory practice that is wide-spread in EU. It prevents online customers from accessing and purchasing products or services from a website based in another member state

Speakers: Felipe Florez Duncan, Marine Elgrichi, J. Scott Marcus, Fabian Paagman, Bertin Martens, Georgios Petropoulos, Agustin Reyna, Werner Stengg and Roza von Thun Topic: European Macroeconomics & Governance, Innovation & Competition Policy Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read about event

Upcoming Event

May
31
12:30

Inclusive growth: global and European lessons for Spain

Can manufacturing still be a driver for inclusive growth around the world? What European and national policies can foster inclusive growth in Europe? What is the situation in Spain and what can Spain learn from the global and European experiences?

Speakers: Cristina Cabrera, Zsolt Darvas, Maria Demertzis, Alejandra Kindelán, Robert Lawrence and Federico Steinberg Topic: European Macroeconomics & Governance, Global Economics & Governance Location: Calle Los Madrazo 36-38 Madrid
Read about event More on this topic

Upcoming Event

Jun
1-2
08:30

Fiscal frameworks in europe: background and perspectives

On 1-2 June Bruegel together with Danmarks Nationalbank and the Copenhagen Business School will organise a conference about fiscal frameworks in Europe. The conference will re-evaluate fiscal frameworks in Europe in light of experience gathered since the formation of the Economic and Monetary Union (EMU). The implications for the design of fiscal policy stemming from […]

Topic: European Macroeconomics & Governance Location: Danmarks Nationalbank
Read about event More on this topic

Past Event

Past Event

Can EMU survive a multi speed Europe?

On 6 April Bruegel, as in previous years, hosted the presentation of the Euro Yearbook, a collection of experts’ insights on the construction of the European Monetary Union through 2016.

Speakers: Pablo Zalba Bidegain, Maria Demertzis, Fernando Fernandez, Javier Méndez Llera, Karl Pichelmann and Guntram B. Wolff Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: April 6, 2017
Read about event

Past Event

Past Event

Micro- and macro-based methods in assessing the impact of investment

This workshop will discuss methods for accurately evaluating the performance of public and private investment initiatives.

Speakers: Francesco Di Comite, Grégory Claeys, Zsolt Darvas, Helmut Kraemer- Eis, Áron Gereben, Robert P. Lieli, Simon Mizrahi, Amine Ouazad, Debora Revoltella, John K. Swales, Simone Signore, Natacha Valla, Marcin Wolski and Guntram B. Wolff Topic: European Macroeconomics & Governance, Finance & Financial Regulation Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: April 5, 2017
Read article More on this topic More by this author

Blog Post

B Coeuré - photo

Central bank communication in a low interest rate environment

Speech by Benoît Cœuré, Member of the Executive Board of the ECB, at an event organised by Bruegel, Brussels, 31 March 2017

By: Benoît Coeuré Topic: European Macroeconomics & Governance Date: March 31, 2017
Read about event More on this topic

Past Event

Past Event

Central bank communication in a low interest rate environment

At this event, we are pleased to welcome Mr. Benoît Coeuré, Member of the Executive Board of the European Central Bank at Bruegel.

Speakers: Benoît Coeuré and Guntram B. Wolff Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: March 31, 2017
Read article More on this topic

Blog Post

Zsolt Darvas
DSC_0798
dsc_1000

The UK’s Brexit bill: what are the possible liabilities?

The EU-UK financial settlement will be a complex part of the Brexit negotiations. Here the authors estimate that at end-2018 the EU will have outstanding commitments and liabilities totalling €724bn. Most of these relate to spending after the UK’s likely departure date, but are tied to commitments made during the UK’s EU membership.

By: Zsolt Darvas, Konstantinos Efstathiou and Inês Goncalves Raposo Topic: European Macroeconomics & Governance Date: March 30, 2017
Read article More on this topic

Blog Post

Zsolt Darvas
DSC_0798
dsc_1000

Brexit bill negotiators must answer these 12 questions

Is Brexit a divorce, or is the UK leaving a club? This is the first question to answer as negotatiors discuss the key aspects of the EU-UK financial settlement. The authors present various scenarios, and find that the UK could be expected to pay between €25.4 billion and €65.1 billion. But the final cost can only be calculated after extensive political negotiations.

By: Zsolt Darvas, Konstantinos Efstathiou and Inês Goncalves Raposo Topic: European Macroeconomics & Governance Date: March 30, 2017
Load more posts