EU Bank Sovereign Cap May Raise Yields, Central Bank Study Says

  • Bank of Italy paper highlights `sizable' costs of threshold
  • Proposed limits to be discussed by EU finance chiefs this week

European countries may see increased debt-financing costs if the region’s finance ministers approve restrictions on bank holdings of sovereign bonds that the officials will first review this week, a study published by the Bank of Italy showed.

The cap “could lead to increases in sovereign yields,” members of the Rome-based central bank’s financial supervision and economic directorates said in a paper. The “costs of a reform could be sizable, while the benefits are uncertain,” the study said.

EU finance ministers will consider five options for reforming state-debt rules at an April 22 informal meeting in Amsterdam, according to a discussion paper published by the Netherlands, which holds the bloc’s rotating presidency. Pier Carlo Padoan, Italy’s finance minister, said this week that the government of Prime Minister Matteo Renzi is “strongly against” imposing limits on banks’ sovereign holdings. In Italy, domestic state debt accounts for 10.5 percent of banks’ total assets, well above the euro-area average of 4.2 percent, European Central Bank data show.

Restrictions on state-debt holdings “would be a tough constraint, one that would be even more onerous for a high-debt country,” Padoan told lawmakers in Rome on Tuesday, adding that Europe should defer to global regulators on the matter. “It is a global issue” that “has to be dealt with at the global level, the Basel Committee being the suitable venue,” he said.

Unlikely Deal

While finance chiefs will look at the Dutch proposal, they’re unlikely to reach any conclusions at the meeting and may push the issue into the future, according to a person who declined to be identified because the deliberations are sensitive.

State bonds are currently treated mostly as risk-free for regulatory reporting. Germany favors adding risk weights so that banks are less inclined to buy debt from the weakest nations.

The study posted earlier this month on the Bank of Italy’s website pointed out implementation issues for the cap to debt held by lenders. “It is widely agreed that credit ratings of sovereigns issued by rating agencies present important drawbacks, but sound alternatives still need to be found,” the study said.

Bonds from Italy and other euro-region countries are currently backed by the European Central Bank’s 80 billion euro ($91 billion) a month asset-purchase program that is scheduled to run until March 2017.

The paper on the Italian central bank’s website also warned against the risk of limiting lenders ability to buy sovereign debt “during a panic-induced crisis.” In those circumstances, “bond prices tend to move suddenly away from fundamentals” and that “may make the financial system more fragile,” the study said.

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