08 June 2016

Financial Times: Sovereign debt rule changes threaten EU bank finances

Expected changes to regulation could lead to a 30 per cent increase in capital requirements for the main EU banks, according to the research by Fitch, the credit rating agency. [...]

The proposals are controversial, and some eurozone leaders, such as Italy’s Matteo Renzi, have warned that they would block any attempt to cap the amount of government debt that banks can hold.

Alan Adkins, group credit officer at Fitch, said it was likely to be many years before new rules came into force, adding: “We believe policymakers will act cautiously, with careful consideration of the impact and with an appropriate time period.”

Fitch examined five potential scenarios based on the different proposals already made for changing the rules on banks’ investments in government debt.

In the first scenario, banks would be required to use their own internal ratings-based models to calculate the relative riskiness of sovereign debt and its corresponding capital charge. This would result in an extra €15bn capital requirement, Fitch said.

A third of all of the EU’s larger banks already capitalise sovereign debt this way, with most assigning low risk-weightings of below 5 per cent to the overall value of their sovereign holdings.

In a second scenario, sovereign bond exposures would carry a risk-weighting of at least 10 per cent, resulting in €24bn of extra capital requirements.

In a third scenario, risk-weightings would be calculated based on external sovereign debt ratings, resulting in a €67bn increase in capital requirements. The fourth scenario combines both the 10 per cent risk-weighting floor and external credit ratings to increase capital requirements by €95bn.

The fifth scenario adds a soft cap that penalises banks with progressively higher charges against their holdings of a country’s sovereign debt above a certain level. This would increase capital requirements by €170bn.

Most of the largest banks, which are classed by regulators as globally systemic, already take capital charges against their sovereign debt holdings. Fitch said that smaller banks, particularly those with high concentrations of debt in riskier countries, would be hardest hit, including those in Portugal, Italy and Spain. [...]

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Fitch Ratings study

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