Weidmann Says Ending Sovereign-Debt Privilege Would Spur Lending

European Central Bank Governing Council member Jens Weidmann said ending the preferential treatment given to sovereign bonds on bank balance sheets would help increase lending to the private sector.

“Ending the preference given to sovereign debt with respect to corporate loans would be an important step in making credit to companies more attractive,” Weidmann, who leads Germany’s Bundesbank, said in a speech in Hamburg today. “The sovereign risks on bank balance sheets, which have in places increased during the crisis, are partly due to the fact that government bonds don’t have to be backed by capital and that there are no upper limits for sovereign debt held.”

European Union regulations classify the region’s government debt on bank balance sheets as risk-free, even as that has passed the effects of governments’ fiscal difficulties through to the financial system. That has squeezed credit as lenders in the countries worst affected by the sovereign debt crisis try to repair their balance sheets. Lending to companies and households in the euro area contracted for 15 months through July, ECB data show.

At the same time, “higher capital requirements for banks are of decisive importance,” Weidmann said. “They ensure that banks can shoulder losses out of their own resources, and thereby transfer the risk back to the owners. This process started with the Basel-III regulation and has to be consistently implemented.”

Fiscal Softening

Weidmann said that the measures undertaken by the ECB in the past year, including interest rate cuts, unlimited liquidity provision to banks and forward guidance on rates, were “basically correct” and helped to limit the effects of the debt crisis.

“However, the effectiveness of loose monetary policy decreases with the duration of the low interest-rate phase, and financial-stability risks increase,” Weidmann said. The withdrawal of such loose policy “becomes more difficult,” he said.

The Bundesbank president also said that it “isn’t right” that new fiscal rules for member states agreed by the EU have already been softened, allowing countries including Spain and France more time to rein in their budgets deficits

“Such a watering-down should only be undertaken in well-founded exceptional cases,” Weidmann said. “Over the long term, only solid national finances can secure sustainable growth.”

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