Europe could be facing a new sovereign-bank “doom loop” if a coronavirus crisis surge in government bond buying by banks in those same countries persists, rating agency S&P Global has warned.
The “doom loop” was at the heart of the euro zone debt crisis when banks had huge holdings of their own governments' debt. As it tumbled in value the banks needed bailing out which made the governments' debt problems even worse.
A report on Monday by S&P said the European sovereign-bank ‘nexus’ – where banks buy bonds issued by the countries they are based in – has deepened by €210-billion ($247.8-billion) since start of the pandemic.
“Despite European governments' efforts to increase risk sharing of the fiscal cost of the pandemic, we have seen few signs of this on the part of European banks,” S&P said.
“In contrast, they have concentrated more risk to their home country by buying more home country sovereign debt, especially in countries with the highest share, increasing the risks of a new doom loop if this trend persists.”
The share of ‘home’ sovereign debt that domestic banks hold varies greatly from country to country in Europe, S&P added.
In countries like Germany and France, it is typically about 5% and 10% of total private-sector lending. For many other economies, like Spain and Portugal, the ratio is closer to 20%, whilst in some central or eastern European countries the ratio is close to 50%, the ratings agency said.
“Although it’s a fairly remote scenario at this stage in Europe, in case of sovereign distress and higher credit spreads for government bonds, banks would have to devalue their sovereign debt security holdings causing asset losses and weakening capital adequacy,” S&P said.
It added it was even more important to watch in light of the large-scale loan guarantee schemes that have been put in place to help firms, and that increasing governments' contingent liability risks across Europe.
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