European banks are doing something that has bothered them for years: loading up government debt, trade investors are calling the “doom curve”.
Banks in the eurozone, full of surplus money with Covid-19 central bank relief efforts, bought nearly € 200bn in government debt from their home countries in the year to September. That has raised their holdings by 19% to € 1.2tn, according to the European Central Bank.
This comes against the backdrop of a large government and central bank-backed support package. The ECB has been buying large volumes of eurozone government bonds, keeping their prices stable and making the investment safe for banks.
The fear is that government finances are becoming increasingly fragile behind the support, as countries borrow aggressively to counter the effects of the Covid-19 pandemic.
It recalls memories of the last financial crisis in Europe early in the last decade. In 2012, what began as a struggle with weaker eurozone countries to repay debt turned into a financial crisis. Banks held down mountains of government bonds that fell in value, spurred by falling rates that pushed up bank lending costs, leading to a credit crunch that slowed economic growth. That hit government finances and followed the wrong loop between banks and their landlords.
“In Europe you cannot accept with certainty that the ECB will always be involved,” said Jérôme Legras, head of research at Axiom Alternative Investments.
Italian and Spanish banks currently hold around a fifth of their countries’ debt, according to the ECB.
For now, markets are vulnerable to the risks. Borrowing costs for banks and governments are near or at all-time low levels. The additional interest that Italy has to pay on its 10-year bonds is at a narrower rate compared to similar German debt – around 1.1 percentage points – from 2018. Recently 10 negative Portuguese year for the first time.
“The threat is close to zero for two or three years. But after that, the situation will change radically ”once investors begin to assess the debt stability of some countries, said Lorenzo Codogno, a former chief economist at the Italian Treasury Department.
The purchase comes as governments are taking out more debt than ever before trying to raise money to fight the pandemic of coronavirus. Italy’s public debt is expected to grow nearly 160% of gross domestic product this year and remain around that level at least through 2022, according to the European Commission. It was 135% last year.
The ECB also gives banks free credit to encourage lending. An easy way for banks to make money with the program is to buy government bonds that outweigh the cost of borrowing.
Banco Bilbao Vizcaya Argentaria, Spain’s second-largest lender with funds, increased the holdings of Spanish bonds by 35% in the first six months of the year to around € 34bn. “The increase is aimed at improving the cost of over-liquidity following the full adoption of the ECB’s lending program,” a spokesman for the bank said.
In Italy, Intesa Sanpaolo, the second largest Italian bank by a major asset and a major buyer of Italian debt, increased its domestic holdings by 18% this year to € 40bn in September.
Marco Troiano, deputy head of the banking team at rating group Scope Ratings, points out that Intesa and UniCredit, Italy’s largest asset-backed bank, were indebted to the sovereign of Italy. June valued at more than 80% of their key equity level 1, key measure. of banks’ ability to withstand losses. At many smaller banks, the figure exceeded 200%.
“Intesa Sanpaolo continues to hold Italian sovereignty bonds below 50% of its total sovereign allowances, a level which executives and investors find comfortable,” a spokesman for the bank said. .
A spokesman for UniCredit said the bank is in fact opposed to the move, explicitly cutting the debt of Italian sovereigns from 2018. It did not use the ECB’s loan program to enter. your government debt. “We are very comfortable with our landlord holdings,” he said.
Banks attribute very little to no capital to account for sovereign risk because regulators believe these funds are safe. Last year, the German finance minister introduced the idea of ending the extent to which banks can be kept at risk, as a condition for deepening the euro area banking union, meaning that banks would be more sustainable wherever they are based.
Legras is not a concern in the short term as earlier this month the ECB expanded its emergency bond purchase program through March 2022.
Andrew Mulliner, bond package manager at Janus Henderson, which has invested in Italian, Spanish and Portuguese debt, said that with such a low yield, the securities have remained so attractive to private investors. That means banks will have a greater role in purchases.
“It’s a risk amplifier” for banks, Mulliner said. That said, if your landlord is going wrong, your banks are likely to go wrong too, whether they owe a lot of government debt or not. ”
This article was published by The Wall Street Journal.