Germany Wants Investors on the Hook If Euro Members Get Aid

  • ESM requests would trigger automatic maturity extensions
  • Part of broader German plan to limit public borrowing, risks

Chancellor Angela Merkel’s government is pushing for new rules forcing a contribution from investors when cash-strapped euro member states ask for assistance from the bloc’s financial backstop.

Germany is looking at measures including an automatic maturity extension for bonds of nations that apply for European Stability Mechanism aid, the Finance Ministry said in an e-mailed response to questions by Bloomberg News. The plan, part of Germany’s push to limit public borrowing and European Union banks’ exposure to sovereigns, is in an early stage and can’t be implemented by Germany alone, the ministry said.

“Banking risks and risks in public budgets must be reduced and must be decoupled from each other, especially in order to strengthen the banking union,” the ministry said. “Part of that could be the creation of a procedure to restructure government debt, for which the automatic maturity extension in case ESM aid is granted is one of several possible options.”

The move adds to German opposition to plans for an EU deposit insurance system and its demand to end the risk-free treatment of sovereign bonds on banks’ balance sheets. EU finance ministers agreed to continue the discussion this year. Critics say the strategy risks scaring investors away from the 19-nation euro area and antagonizing other euro members still recovering from the debt crisis.

“It exposes the bonds to more volatile market behavior, where the market could drive bond yields much more quickly to threshold levels,” said Elwin de Groot, an economist at Dutch Rabobank. “This would likely raise overall borrowing costs. After all, investors would require a higher compensation for the possibility of being automatically drawn into a debt restructuring.” 

Germany supports EU plans to cut the link between banks and governments and advocates a phased-in risk-weighting of government bonds on bank balance sheets, Deputy Finance Minister Jens Spahn said in a Dec. 7 letter to the German parliament’s European Affairs Committee that outlines both the debt restructuring plan and advances Germany seeks in banking union.

Bundesbank Proposals

The German government is adopting ideas already proposed by the Bundesbank. Maturity extensions would give governments tapping the ESM more time to revamp their economies while keeping investors engaged, President Jens Weidmann said in a speech in November. His fellow board member Andreas Dombret said in an interview this month that banks should brace for higher capital requirements on their sovereign-debt holdings.

Senior lawmakers in Merkel’s Christian Union caucus suggest the automatic maturity extension could also imply a trading ban on bonds issued by a government asking for ESM aid, a measure that may have drastic consequences for government bond markets.

“We realized when we established the ESM that governments aren’t getting into trouble overnight and that private creditors were pulling out along the way when it became foreseeable,” Antje Tillmann, the financial policy spokeswoman of the CDU, said in an interview. “Freezing government bonds for three years at the very moment a government applies for aid could save taxpayer money.”

Such option would have to be limited to future, newly-issued government bonds, Ralph Brinkhaus, a deputy leader of Merkel’s party bloc in parliament, said in an interview. “Such restrictions wouldn’t be had for free, but would be paid for by higher yields and therefore rising costs for issuing countries.”

Changes to the way the ESM works require updating its treaty, which would need approval from all euro members. That means any other member could veto Germany’s proposal, if it advances.

“The shifting of risks from the sovereign to the banks hasn’t been noticeably reduced in the past years, quite the contrary,” Tillmann said. Limiting bank risks tied to government bonds in their balance sheets is an area where Germany wants to see progress and “one should start now,” she added.

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