08 March 2019

Financial Times: Eurozone banks buy sovereign bonds, reviving ‘doom loop’ fear

Banks across the eurozone have begun to stock up on their own governments’ bonds for the first time since the bloc’s debt crisis half a decade ago — even as the European Central Bank launches a fresh round of stimulus to prod them into lending.

Encouraging big banks to supply credit to companies and households has been a centrepiece of the ECB’s policy efforts in recent years, via successive programmes of cheap loans from the central bank. However, some banks have elected to shore up their balance sheets by buying government bonds — which require no capital to be set against them — rather than generating new loans, which do.

ECB president Mario Draghi acknowledged that banks had used some of the central bank’s previous cheap-loan programmes to finance the purchase of sovereign debt. Mr Draghi was speaking as the ECB took markets by surprise in announcing a fresh series of multiyear loans to banks, in a bid to spur growth.

He said that during economic downturns government bonds could deliver returns that look favourable compared with the risks of lending to the real economy, but tweaks to the design of the ECB’s cheap-loan programmes had resulted in banks passing on more cash to businesses and consumers.

However, the ECB’s own data show that eurozone banks have recently begun to increase their sovereign debt holdings once more: they bought a net €1bn of their domestic government’s debt in the 12 months to January.

The figures are likely to revive fears about the effect that swings in the price of government debt can have on banks’ balance sheets — a dangerous dynamic that became known as the “doom loop” during the eurozone debt crisis.

“Bank ownership of sovereign debt is a bit of a doubled-edged sword,” said Marchel Alexandrovich, senior European economist at Jefferies.

“A strong domestic investor base is helpful in difficult times as it means there’s always someone there to buy, but . . . when banks are sitting on large sovereign debt positions it means that a crisis in the fiscal arena can spill over into the bank arena.”

The new scheme announced by the ECB will start in September and end in March 2021. Each operation will have a two-year maturity.

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