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August 21, 2014 6:19 pm
Robust bond buying by eurozone banks has helped push governments’ borrowing costs to record lows amid poor economic data.
Last month, more than a tenth of all banking assets in Spain and Italy consisted of government debt, mostly domestic bonds according to analysts, for the first time since the European Central Bank flooded markets with more than €1tn in cheap loans between 2011-12.
The figures, based on ECB data, have raised fears that banks are increasingly using cheap ECB loans to buy higher-yielding domestic government debt and reaping the profits, known as a ‘carry trade’, instead of lending to consumers and businesses.
Part of the problem is that government debt does not incur any regulatory capital charge while loans to businesses do.
“Banks are still buying sovereign paper because they lack capital to issue loans - loans are weighted between 75-100 per cent of reserves while sovereign bonds weigh zero or nearly zero,” said Alberto Gallo head of macro credit research at RBS.
“A frequent comment from banks is that demand for loans is scarce - but demand depends on price also and the cost of lending is still high in the periphery.”
The figures come as gloomy data from eurozone manufacturers has raised hopes that the ECB will embark on an asset purchasing programme, similar to the US Federal Reserve’s, adding to downward pressure on yields.
Yields on Spanish and Italian 10-year bonds, which move inversely with prices, fell to euro-era lows of 2.39 per cent and 2.59 per cent respectively.
In Portugal investors have shrugged off troubles at the country’s biggest listed lender, Banco Espirito Santo, to send government bond yields to a near-decade low of 3.24 per cent.
“It is related to deflation scares and expectations of the ECB having to intervene in these markets,” said Alessandro Tentori, bond strategist at Citi.
Government debt as a proportion of eurozone banks’ collective assets has increased nearly every month since the end of 2012 and presently stands at 5.9 per cent, up from 4.2 per cent. Portuguese and Irish banks have also increased their government debt holdings, as have core countries such as Germany, Austria, France and the Netherlands, albeit more slowly. The proportion in Greece has fallen sharply over the period.
Previously European regulators have raised the alarm over a growing ‘bank-sovereign’ nexus, highlighting the potentially destabilising interdependency between the region’s financial institutions and national governments.
In June Mario Draghi, ECB president, announced another programme of cheap loans under the bank’s ‘targeted long-term refinancing operations’ but warned against banks using the money to buy sovereign debt.
However, there are doubts over how the ECB can ensure this.
“The TLTRO reduces funding costs and with that, the ECB hopes the savings will be passed onto borrowers,” said Mr Gallo. “But I doubt capital-strapped periphery banks, like the mid-tiers, will be able to do this.”
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