Download publication

External Publication

Sovereign Concentration Charges: A New Regime for Banks’ Sovereign Exposures

Europe’s banking union has been central to the resolution of the euro-area crisis. It has had an encouraging start but remains unfinished business. If it remains in its current halfway-house condition, it may eventually move backwards and fail. EU leaders should seize these opportunities

By: Date: November 17, 2017 Topic: European Macroeconomics & Governance

This material was originally published in a paper provided at the request of the Committee on Economic and Monetary Affairs of the European Parliament and commissioned by the Directorate-General for Internal Policies of the Union and supervised by its Economic Governance Support Unit (EGOV). The opinions expressed in this document are the sole responsibility of the authors and do not necessarily represent the official position of the European Parliament. The original paper is available on the European Parliament’s webpage

© European Union, 2017]. Copyright remains with the European Union at all times.

Europe’s banking union project, initiated in 2012, has had a promising start. But its stated aim of breaking the vicious circle between banks and sovereigns is very far from being achieved. A key bank-sovereign linkage is the euro area’s home-bias problem, namely the fact that the sovereign exposures of many euro-area banks are highly concentrated in the home country, instead of being diversified within the monetary union.

The home-bias problem, in turn, is a key obstacle to the adoption of a European Deposit Insurance Scheme (EDIS), as proposed by the European Commission in late 2015, because of the suspicion that deposits protected by EDIS would be used by banks, under moral suasion from their home country’s government, to excessively increase their purchases of that government’s debt. In turn, the absence of a full EDIS is one of the banking union’s greatest weaknesses because deposits are not protected uniformly.

There is therefore a strong policy case for the simultaneous consideration of EDIS and of a regulatory instrument targeted at reducing highly concentrated sovereign exposures. The adoption of one of these two reforms without the other is both unlikely and arguably undesirable.

To address the home-bias problem, a general and mandatory (Pillar 1) regulatory requirement is necessary. It should focus on sovereign concentration risk rather than sovereign credit risk, constraining only large exposures as opposed to the risk-weighting of all sovereign assets (the latter might also be envisaged, but on the condition of a global consensus and thus presumably at a later stage). Because the home-bias problem is unique to the euro area, the new requirement should only be binding for the euro-area sovereign exposures of euro-area banks.

This paper outlines a workable design for a Sovereign Concentration Charges Regulation (SCCR) as new EU legislation to be adopted as a complement of EDIS. The SCCR would add sovereign exposures above a certain threshold (defined as a ratio to Tier-1 capital), weighted by a coefficient (sovereign concentration charge) that increases with the exposure ratio, to risk-weighted assets in the capital ratio’s denominator. The charges for concentrated sovereign exposures to different euro-area countries would add up.

The proposed calibration for the SCCR errs on the side of leniency, to avert any risk of disturbance in sovereign debt markets. Sovereign exposures under 33 percent of Tier-1 capital would be entirely exempted. The marginal capital charges on concentrated exposures would be mild for exposures up to 100 percent of Tier-1 capital, and rise more steeply above that level. Should this calibration turn out to have an insufficient impact, it could be strengthened at a later stage.

The proposed transitional arrangements are also designed to ensure a smooth path towards the new regime even if market conditions become less favourable than currently. The transitional arrangements include extensive consultation with market participants, a gradual phase-in over a long period and grandfathering (i.e. exemption from the concentration charges) of all debt issued before the SCCR’s entry into force.

The SCCR does not require any consideration of a euro-area ‘safe asset’, but can easily accommodate a safe asset if it is introduced and incentivise its use if deemed appropriate.

While the banks’ behavioural response to the new regime is impossible to predict with certainty, it is expected that most banks will respond to the introduction of the SCCR by diversifying their sovereign exposures away from their current home bias, but leaving them largely unchanged in euro-area aggregate. If so, the reform will neither materially impact banks’ prudential ratios nor entail any material costs.

The adoption of the proposed SCCR together with a full EDIS, ideally complemented by other reforms to increase risk-sharing and enhance market discipline in the banking policy framework, would significantly reduce bank-sovereign linkages and thus strengthen the banking union, foster greater EU financial integration, and increase financial stability for each member state and for the European Union as a whole.

View comments
Read article Download PDF More on this topic More by this author

External Publication

Taking stock of the Single Resolution Board: Banking union scrutiny

The Single Resolution Board (SRB) has had a somewhat difficult start but has been able to learn and adapt, and has gained stature following its first bank resolution decisions in 2017-18. It must continue to build up its capabilities, even as the European Union’s banking union and its policy regime for unviable banks continue to develop.

By: Nicolas Véron Topic: European Macroeconomics & Governance Date: April 18, 2019
Read about event More on this topic

Past Event

Past Event

Spitzenkandidaten series: Frans Timmermans

The sixth event in the The Road to Europe - Brussels Briefing Live: Spitzenkandidaten series. The series features the lead candidates for the European Elections of six parties and is jointly organised by Bruegel and the Financial Times in March and April 2019.

Speakers: Mehreen Khan, André Sapir and Frans Timmermans Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: April 11, 2019
Read about event More on this topic

Past Event

Past Event

Spitzenkandidaten series: Manfred Weber

The fifth event in the The Road to Europe - Brussels Briefing Live: Spitzenkandidaten series. The series features the lead candidates for the European Elections of six parties and is jointly organised by Bruegel and the Financial Times in March and April 2019.

Speakers: Anne-Sylvaine Chassany, Manfred Weber and Guntram B. Wolff Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: April 9, 2019
Read article Download PDF More on this topic More by this author

Working Paper

Europe in the midst of China-US strategic competition: What are the European Union's options?

With the trade conflict between the United States and China bringing China-US strategic competition into the open, the European Union faces an urgent question: how to position itself in the competition.

By: Alicia García-Herrero Topic: Global Economics & Governance Date: April 8, 2019
Read about event More on this topic

Past Event

Past Event

Spitzenkandidaten series: Jan Zahradil

The fourth event in the The Road to Europe - Brussels Briefing Live: Spitzenkandidaten series. The series features the lead candidates for the European Elections of six parties and is jointly organised by Bruegel and the Financial Times in March and April 2019.

Speakers: Jim Brunsden, Maria Demertzis and Jan Zahradil Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: April 4, 2019
Read article More by this author

Opinion

Europe and the new imperialism

For decades, Europe has served as a steward of the post-war liberal order, ensuring that economic rules are enforced and that national ambitions are subordinated to shared goals within multilateral bodies. But with the United States and China increasingly mixing economics with nationalist foreign-policy agendas, Europe will have to adapt.

By: Jean Pisani-Ferry Topic: Global Economics & Governance, Innovation & Competition Policy Date: April 3, 2019
Read about event More on this topic

Past Event

Past Event

Spitzenkandidaten series: Luis Garicano

The third event in the The Road to Europe - Brussels Briefing Live: Spitzenkandidaten series. The series features the lead candidates for the European Elections of six parties and is jointly organised by Bruegel and the Financial Times in March and April 2019.

Speakers: Luis Garicano, Mehreen Khan and Guntram B. Wolff Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: April 3, 2019
Read about event More on this topic

Past Event

Past Event

Spitzenkandidaten series: Bas Eickhout

The second event in the The Road to Europe - Brussels Briefing Live: Spitzenkandidaten series. The series features the lead candidates for the European Elections of six parties and is jointly organised by Bruegel and the Financial Times in March and April 2019.

Speakers: Bas Eickhout, Guntram B. Wolff and Rochelle Toplensky Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: April 2, 2019
Read article More on this topic

Opinion

Brexit: When in doubt, slow down

Uncertainty over Brexit remains high despite looming deadlines. Here, the authors argue that the UK should take the necessary steps to make time to build consensus around the final shape of Brexit, and that the UK population should be consulted.

By: Maria Demertzis and Nicola Viegi Topic: European Macroeconomics & Governance Date: March 29, 2019
Read article More on this topic More by this author

Opinion

Takeaways from Xi Jinping’s visit to France and Italy and ideas for the EU-China summit

The author appraises China's strategy towards Europe ahead of next month's EU-China summit.

By: Alicia García-Herrero Topic: Global Economics & Governance Date: March 27, 2019
Read about event More on this topic

Past Event

Past Event

Spitzenkandidaten series: Yanis Varoufakis

The first event in the The Road to Europe - Brussels Briefing Live: Spitzenkandidaten series. The series features the lead candidates for the European Elections of six parties and is jointly organised by Bruegel and the Financial Times in March and April 2019.

Speakers: Maria Demertzis, Martin Sandbu and Yanis Varoufakis Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: March 26, 2019
Read article More on this topic More by this author

Blog Post

The shadow of Brexit: Guessing the economic damage to the UK

Under a set of assumptions, this post concludes that UK real income and investment would have been 4% and 6% larger respectively had it not been for the shock of the Brexit referendum result. With somewhat audacious assumptions, the damages already incurred can be scaled up to guess the negative macroeconomic consequence of each of the three possible Brexit outcomes: no-deal, deal or no Brexit.

By: Francesco Papadia Topic: European Macroeconomics & Governance Date: March 21, 2019
Load more posts