Blog Post

Whose (fiscal) debt is it anyway?

The authors map how much fiscal debt is in the hands of domestic and foreign holders in the euro area. While the market for debt was much more international prior to the crisis, this trend has since been reversed. At the same time, central banks have become important holders of fiscal debt.

By: and Date: February 6, 2019 Topic: European Macroeconomics & Governance

Figure 1 depicts the evolution of euro-area general government debt and whether it is in domestic or foreign hands. The investor base varies significantly across countries, but we do observe general trends that inform our understanding in this respect.

Between 1995 and 2007, financial integration in the euro area led to a diversification of the investor base. The share of resident investors (and in particular domestic banks) dropped from 72% and 35% to 48% and 25% respectively, during a period in which outstanding debt as a share of GDP generally declined.

During the crisis, however, this trend reversed, as foreign investors withdrew cross-border holdings and domestic banks increased their exposure, in particular in countries that were hit hardest by the sovereign-debt crisis.

As a consequence, domestic investors now hold more sovereign debt, in absolute and relative terms, than in 2007. However, what is also true is that there is a partial shift within the domestic investor base, from banks to the central banks. Indeed, domestic central banks bought a significant share of sovereign bonds (mainly from foreign investors) within the scope of the ECB’s quantitative easing (QE) programme.

The ownership structure of national debt is extensively discussed in the light of cross-border risk sharing within a monetary union like the euro area. Economic research highlights that regional shocks can be partly absorbed by cross-holdings of assets. Indeed, risk sharing is most effective if both debt and equity markets are well integrated (e.g. Asdrubali et al, 1996).

Furthermore, greater domestic ownership of public debt is associated with relatively higher longer-term yields. A higher demand by foreign investors implies lower long-term yields on debt. However, the direction of causality is not clear: low yields could attract international investors, while increased international demand could reduce borrowing costs.

At the same time there are risks associated with a home bias of investors as it creates a dangerous link between financial institutions and national fiscal policy which can amplify shocks. However, in times of stress, a home bias in ownerships acts as a cushion. Foreign owners of domestic debt are quicker to sell it, increasing both refinancing costs (see here and here) for the country, as well as the threat of sudden stops. Relying on domestic ownership can act as a stabilising force.

Borrowing Cost

Figure 2 demonstrates how the negative relation between a higher share of foreign investors and the refinancing costs have played out in the EU since 2007. The reduction in the share of foreign investors between 2007 and 2018 went hand-in-hand with an increase in the spread to the ECB’s main refinancing rate (MRO) (the spread to the MRO is defined as the difference between a country’s annual average 10-year bond yield and the annual average MRO rate). A notable exception in this graph is the Netherlands, which witnessed a substantial decrease in the share of foreign investors but with a marginal increase in the spread.

Figure [2]: Pre-crisis vs current situation: foreign investors’ sovereign bond holdings and spread to MRO (start: 2007 end: 2018)

Source: Bloomberg, Arslanalp and Tsuda (2012)

Note: The spread to the MRO is defined as the difference between a country’s annual average 10-year bond yield and the annual average MRO rate.

On the other hand, the ECB’s QE programme has tied up a significant share of total sovereign bonds in national central banks’ balance sheets, which limits supply on the secondary market. Research has found that this has lowered yields and therefore, muted the increase in yields caused by lower foreign demand (e.g. Krishnamurthy, Nagel, and Vissing-Jorgensen, 2018 and Ghysels et al. 2017).

Has the doom-loop weakened?

Figure 3 shows the evolution of banks’ exposure to domestic and other euro-area sovereign debt since 2007. We observe that for most countries (except Belgium, France and Greece), banks own more of their own sovereign bonds as a share of total assets than they did prior to the crisis. However, this trend has reversed since 2014 for all countries shown, except Greece, Italy and Portugal.

There is a mixed picture when it comes to how much sovereign debt issued by other euro-area countries is held by banks. Greece, Italy, Portugal and Spain have seen a clear increase, but for the rest there is probably a small decline – especially since 2014.

While there is arguably a general tendency to hold small and declining shares of any sovereign debt (after all, the numbers in Figure 3 are well below 10% for most), the home bias remains a prime characteristic of banks’ balance sheets.

There is more fiscal debt today than there was before the crisis, and in most cases more even than there was in the mid-90s. And it continues to lie mostly in the hands of domestic investors with the central bank becoming a sizable owner following QE. On the one hand, this is a reflection of the fragmented fiscal quality of the sovereigns in economic and monetary union, and does not help correct the doom loop that proved so destructive during the fiscal crisis. Although the increased home bias insulates countries from affecting each other through the banking system, it implies a thoroughly incomplete monetary union.

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 More on this topic More by this author

Blog Post

European green finance is expanding, a discount on bank capital would discredit it

If EU banks are to mobilise a greater share of loans for sustainable projects they will need a reliable policy framework, clear internal performance targets and the relevant skills. A discount on bank capital underlying such assets is neither justified nor likely effective. A comprehensive review of how climate risks are reflected in prudential regulation is nevertheless in order

By: Alexander Lehmann Topic: Energy & Climate Date: January 15, 2020
Read article Download PDF More on this topic

Policy Contribution

Market versus policy Europeanisation: has an imbalance grown over time?

This Policy Contribution tests the hypothesis that an imbalance has grown in Europe over the last few decades because markets have integrated to a greater extent than European-level policymaking, potentially creating difficulties for the democratic process in managing the economy. This hypothesis has been put forward by several authors but not so far tested empirically.

By: Francesco Papadia and Leonardo Cadamuro Topic: European Macroeconomics & Governance Date: January 9, 2020
Read article Download PDF More by this author

Policy Contribution

Crisis management for euro-area banks in central Europe

Euro-area bank integration has decreased as post-financial crisis national rules require banks to hold more capital at home. It might be undermined further by bank resolution planning. Either a Single Resolution Board takes the lead for the entire banking group or independent local intervention schemes need to be developed for crisis resolution.

By: Alexander Lehmann Topic: European Macroeconomics & Governance, Finance & Financial Regulation Date: November 19, 2019
Read article More on this topic


Politics, not policy will help Lagarde save the eurozone

Her success at helm of Europe’s central bank will depend on her ability to mend fences with hawkish policymakers.

By: Guntram B. Wolff and Rebecca Christie Topic: European Macroeconomics & Governance Date: November 4, 2019
Read article More on this topic More by this author

Blog Post

Long term real interest rates fell below zero in all euro area countries

The 10-year real government bond yield, which is the nominal yield deflated by expected inflation, has fallen below zero in Italy and Greece, boosted by increased market confidence for their new governments. Romania is the only remaining EU country with a positive real interest rate. Negative real interest rates vastly help fiscal sustainability and provide a great opportunity to invest in much needed infrastructure and the transition to a carbon-neutral economy.

By: Zsolt Darvas Topic: European Macroeconomics & Governance Date: October 8, 2019
Read article More on this topic More by this author


How to ward off the next recession

Despite confident official pronouncements, the deteriorating state of the global economy is now high on the international policy agenda. The OECD recently revised down its forecasts to 1.5% growth in the advanced G20 economies in 2020, compared to almost 2.5% in 2017. And its chief economist Laurence Boone warned of the risk of further deterioration – a coded way of indicating a growing threat of recession.

By: Jean Pisani-Ferry Topic: Global Economics & Governance Date: October 2, 2019
Read article Download PDF

External Publication

European Parliament

Challenges ahead for the European Central Bank: Navigating in the dark?

Since the second half of 2018, signs of a slowdown have been piling up in the euro area. The ECB will face major challenges in this potentially difficult period: its main tools are nearly exhausted, the monetary union in which it operates is still incomplete, and it lacks the understanding of what the ‘new normal’ looks like. The authors, therefore, urge the ECB to review its strategy and framework to be able to face these challenges.

By: Grégory Claeys, Maria Demertzis and Francesco Papadia Topic: European Macroeconomics & Governance, European Parliament, Testimonies Date: September 25, 2019
Read article Download PDF More on this topic

External Publication

Simple Rules for Better Fiscal Policies in Europe

Proposals to reform the euro area are on the agenda again. An overhaul of the complex set of European fiscal rules should be top priority on this agenda because the fiscal framework in place suffers from clearly identified problems: rules are complex (therefore difficult to internalise for policymakers), pro-cyclical (therefore potentially destabilising), and noncompliance is the norm (therefore not credible).

By: Zsolt Darvas, Xavier Ragot, Philippe Martin, Jean Beuve and Samuel Delpeuch Topic: European Macroeconomics & Governance Date: September 24, 2019
Read article More on this topic More by this author



Backstage at BAM19: Priorities for Europe's monetary union

Backstage at the Bruegel Annual Meetings, Nicholas Barrett talks with Zsolt Darvas on Europe's monetary union.

By: The Sound of Economics Topic: European Macroeconomics & Governance Date: September 5, 2019
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 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

‘Lo spread’: The collateral damage of Italy’s confrontation with the EU

The authors assess whether the European Commission's actions towards Italy since September 2018 have had a visible impact on the spread between Italian sovereign-bond yields and those of Germany, and particularly whether the Commission’s warnings have acted as a ‘signalling device’ for bond-market participants that it might be difficult for Italy to obtain the support of the ESM or the ECB’s OMT programme if needed.

By: Grégory Claeys and Jan Mazza Topic: European Macroeconomics & Governance Date: July 8, 2019
Load more posts