July 9, 2019 / 12:50 PM / a month ago

Euro zone tries to revive pooled debt plan, ending risk-free government bonds

BRUSSELS (Reuters) - The head of the Eurogroup of euro zone finance ministers is proposing to revive talks on a plan to pool the debt of euro zone countries, three EU sources told Reuters on Tuesday, in a bid to reduce the shortage of triple-A rated bonds in the bloc.

The plan aims to overcome opposition to the idea of a euro zone safe asset by offering reluctant states the prospect of making government bond holdings more expensive for banks - thus limiting their exposure.

The proposal by Eurogroup President Mario Centeno was received “with caution” by finance ministers at a meeting on Monday, the sources said.

A persistent shortage of triple-A rated bonds has kept momentum for a pooled euro zone sovereign bond alive despite opposition from Germany. The euro zone’s largest economy has so far rejected any proposal that could potentially leave its taxpayers on the hook for the debts of other countries.

At Monday’s meeting, Centeno proposed to set up three working groups to address contentious issues that have so far prevented a reform of the euro zone, officials said, suggesting they conclude their work by December.

One group would focus on the “Regulatory Treatment of Sovereign Exposures”, the officials said. Debt of euro zone countries is currently considered risk-free - favourable treatment compared with other securities that has encouraged banks to pile up sovereign bonds in their balance sheets.

Lenders mostly buy debt from their own countries, exposing them to market pressure when governments’ fiscal policies are seen as imprudent - that is the so-called doom-loop that worsened the euro zone’s financial crisis in the last decade and it is still a major concern for high-debt nations.

The average European bank now has sovereign debt exposure equal to 170% of its core tier one capital, a key measure of a bank’s financial strength, according to a Deutsche Bank analysis. That is more than triple the exposure of U.S banks.

Germany and other states with lower debts want to end the doom-loop by making sovereign bonds’ holdings more expensive for banks, forcing them to set aside capital against sovereign debt risks.

This is however opposed by states like Italy who have large portions of their high debts stacked on domestic banks. They fear such a move would increase yields on their bonds, causing risks to financial sustainability.

SAFE ASSET

To persuade high-debt states, Centeno proposed to ministers that they discuss the reviewed treatment of government bonds together with a plan to pool part of the debt of euro zone countries.

States that are most indebted have low credit ratings, which make their bonds more expensive and prevent their sale to large investors.

The share of the safest, triple-A rated sovereign bonds that come from the euro zone has dropped from about half before the financial crisis to around 25% currently, as the rating of public debt in several euro zone states deteriorated.

By pooling some of the euro zone debt, the overall rating of the bloc’s bonds would rise. This would attract more liquidity to the euro zone and could strengthen the role of the euro as a reserve currency challenging the dollar dominance, supporters of the plan say.

Germany has long opposed the idea of a safe asset, fearing it would increase its debt servicing costs, while Italy backs the idea.

At Monday’s meeting, “a couple” of countries confirmed their opposition to discussing safe assets, but work will start anyway on the matter, officials said.

Centeno proposed to tackle the issue in the context of the wider reform of the euro zone, which would also include separate discussions on common insurance for bank depositors - another plan that has been blocked for years - and on clarifications of banks’ capital requirements in their home states and in those where they have subsidiaries.

Reporting by Francesco Guarascio @fraguarascio, Editing by William Maclean

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