Sovereign Debt Risk at EU Banks Tied to Deposit Insurance Debate

  • Dijsselbloem: EU must deal with high concentration of risk
  • French say deposit insurance shouldn't be conditionally linked

Sovereign debt has to play a smaller role in banks’ balance sheets across the European Union if common deposit insurance is to gain broad support, according to Dutch Finance Minister Jeroen Dijsselbloem.

Regulators can address sovereign risk by imposing concentration limits or adding new risk weights for government debt holdings, said Dijsselbloem, whose nation takes over the EU’s rotating presidency on Jan. 1. The EU also must decide how to impose a leverage ratio on the financial sector before it can expand its banking union, he said.

“If you want a European deposit guarantee, risks should be reduced first,” Dijsselbloem said on Tuesday. “One of them is a high concentration of government debt on the balance sheets of several banks. That should be dealt with.”

Common deposit insurance is an anchor of European Commission President Jean-Claude Juncker’s proposals to strengthen the euro in the aftermath of the financial crisis. The plan, proposed last month, calls for an eight-year transition to a common fund that would safeguard bank accounts with up to 100,000 euros ($109,000).

German Opposition

Germany immediately opposed the plan, prompting the Brussels-based commission to say the EU would pursue ways to reduce banking risk alongside the move to strengthen government safeguards. Sovereign debt risk is one of the issues to be addressed, though no specific goals or timetables have been set.

Any move to make banks account for government debt risks would have enormous impact on the industry. Right now, European banks generally are allowed to treat sovereign debt as if it could not default, so any move to add risk weighting or limit the concentration of bond holdings could cause shocks. As a result, global regulators have been investigating the issue and proceeding with caution before making any moves.

France will push for the deposit insurance plan to remain on a separate track from any move to change how regulators deal with sovereign risk, a French official said. Mutualization of risk must proceed alongside improving banking practices, without the two issues being conditional on each other, the official said.

Parallel Talks

It’s too simplistic to suggest that Germany would call for sovereign risk -- particularly at banks in peripheral nations -- to be addressed before deposit insurance can proceed, the French official said. German politicians are glossing over the technical aspects of such a change, because standardizing of banking practices like sovereign risk weighting will be unpleasant for all nations, the official said.

Luxembourg Finance Minister Pierre Gramegna said the talks will need to proceed in parallel.

“I think the German position has to be seen on a time scale,” said Gramegna, whose nation currently holds the EU presidency. “Germany says the countries first have to pay into the resolution fund, they have to make sure that bank safety in their countries is assured and then there can perhaps be a deposit insurance at European level step by step.”

The euro area’s banking union began with common supervision, now handled by the European Central Bank. Non-euro nations have the option of joining the framework, which as of Jan. 1 will include the Single Resolution Mechanism for dealing with failing banks.

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