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 More on this topic More by this author

External Publication

La Banca centrale europea

This external publication delves into the new responsibility given to the European Central Bank: supervision on banks in the euro-area. It tells its history and illustrates its functions, structure and responsibilities and the exceptional answers to respond to the "perfect storm" of the crisis.

By: Francesco Papadia Topic: European Macroeconomics & Governance Date: July 31, 2019
Read article Download PDF More on this topic More by this author

External Publication

An Effective Regime for Non-viable Banks: US Experience and Considerations for EU Reform

The US regime for non-viable banks has maintained a high degree of stability and public confidence by protecting deposits, while working to minimise the public cost of that protection. EU reformers can draw valuable insights from the US experience. A review of the US regime supports arguments in favour of harmonisation and centralisation of bank insolvency proceedings and deposit insurance in Europe’s banking union.

By: Nicolas Véron Topic: Finance & Financial Regulation Date: July 22, 2019
Read article More on this topic More by this author

Opinion

The EU needs a bold climate strategy

Scientists report that global temperature increases must be limited to below 1.5 degrees Celsius. With global greenhouse gas emissions continuing to increase and rising temperatures driving up the frequency of extreme weather events, the world needs a greater commitment to climate policy.

By: Guntram B. Wolff Topic: Energy & Climate Date: July 19, 2019
Read article More on this topic More by this author

Blog Post

Croatia’s path into the banking union

Croatia seems a suitable candidate for euro area accession: there is a tight peg to the euro, high public debt is coming down, and the banking sector is already dominated by euro area banks. But the Eurogroup has rightly targeted reforms of the state’s role in the economy as a precondition for participation in ERM II and the banking union. None of the announced reform plans are new or easily concluded within the timeframe that has now been agreed.

By: Alexander Lehmann Topic: European Macroeconomics & Governance Date: July 18, 2019
Read article More on this topic

Blog Post

Talking about Europe: Die Zeit and Der Spiegel 1940s-2010s

An on-going research project is seeking to quantify and analyse printed media discourses about Europe over the decades since the end of the Second World War. A first snapshot screened more than 2.8 million articles in Le Monde between 1944 and 2018. In this second instalment we carry out an analogous exercise on a dataset of more the 500 thousand articles from two German weekly magazines: Die Zeit and Der Spiegel. We also report on the on-going work to refine the quantitative methodology.

By: Enrico Bergamini, Emmanuel Mourlon-Druol, Francesco Papadia and Giuseppe Porcaro Topic: European Macroeconomics & Governance Date: July 18, 2019
Read article More on this topic More by this author

Blog Post

How should the relationship between competition policy and industrial policy evolve in the European Union?

Competition policy aims to ensure that market practices and strategies do not reduce consumer welfare. Industrial policy, meanwhile, aims at securing framework conditions that are favourable to industrial competitiveness, and deals with (sector-specific) production rules as well as the direction of public funds and tax measures. But, how should competition policy and industrial policy interact? Is industrial policy contradicting the aims of competition policy by promoting specific industrial interests?

By: Georgios Petropoulos Topic: Innovation & Competition Policy Date: July 15, 2019
Read about event More on this topic

Past Event

Past Event

The 4th industrial revolution: opportunities and challenges for Europe and China

What is the current status of EU-China relations concerning innovation, and what might their future look like?

Speakers: Elżbieta Bieńkowska, Chen Dongxiao, Patrick Child, Eric Cornuel, Maria Demertzis, Ding Yuan, Luigi Gambardella, Jiang Jianqing, Frank Kirchner, Pascal Lamy, Li Mingjun, Gwenn Sonck, Gerard Van Schaik, Reinhilde Veugelers, Wang Hongjian, Guntram B. Wolff, Xu Bin, Zhang Hongjun and Zhou Snow Topic: Global Economics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: July 12, 2019
Read article Download PDF More on this topic

Policy Brief

The European Union energy transition: key priorities for the next five years

The new members of the European Parliament and European Commission who start their mandates in 2019 should put in place major policy elements to unleash the energy transition. It is becoming economically and technically feasible, with most of the necessary technologies now available and technology costs declining. The cost of the transition would be similar to that of maintaining the existing system, if appropriate policies and regulations are put in place.

By: Simone Tagliapietra, Georg Zachmann, Ottmar Edenhofer, Jean-Michel Glachant, Pedro Linares and Andreas Loeschel Topic: Energy & Climate Date: July 9, 2019
Read article More on this topic More by this author

Podcast

Podcast

Director's Cut: Priorities for the new ECB president

In this Director's Cut of 'The Sound of Economics', Guntram Wolff talks to two of the authors of Bruegel's memo to the new ECB president, Maria Demertzis and Grégory Claeys, to specify the most important issues at the beginning of this eight-year cycle and to clarify the parameters within which the new incumbent will have to work.

By: The Sound of Economics Topic: European Macroeconomics & Governance Date: July 4, 2019
Read article Download PDF

Policy Brief

The threats to the European Union’s economic sovereignty

Memo to the High Representative of the Union for Foreign Affairs and Security Policy. The authors describe the current context and the increasing interlinkages between economics and power politics and the role to play in reinforcing and defending Europe’s economic sovereignty.

By: Jean Pisani-Ferry and Guntram B. Wolff Topic: European Macroeconomics & Governance, Global Economics & Governance Date: July 4, 2019
Read article Download PDF More on this topic

Policy Brief

Preparing for uncertainty

Memo to the president of the European Central Bank. Grégory Claeys, Maria Demertzis and Francesco Papadia present the challenges that the next ECB president will face during the upcoming mandate, reinventing monetary policy in a system riddled with uncertainties.

By: Grégory Claeys, Maria Demertzis and Francesco Papadia Topic: European Macroeconomics & Governance Date: July 3, 2019
Read article More on this topic More by this author

Blog Post

Where Brexit goes, the law shall follow

How the financial industry and the law firms that support it are preparing for what comes next

By: Rebecca Christie Topic: European Macroeconomics & Governance Date: June 25, 2019
Load more posts