European banks have loaded up on more than €200bn of their own governments’ bonds since the start of the Covid-19 pandemic, in a move that could reawaken fears about the sector’s growing stockpiles of risky sovereign debt.
According to research by S&P Global Ratings, banks had increased their holdings of home-country government bonds to nearly €1.6tn by the end of June, up 15 per cent from the end of February. The rating agency said the pace of purchases was seven times faster than in the same period in 2019.
S&P said banks in the eurozone’s former crisis-hit “periphery” — such as Italy, Greece and Spain — have the highest exposure to their governments’ debt, along with those outside the euro area in central and eastern Europe.
The figures are likely to revive concerns about the effect that wild swings in the price of government bonds could have on banks’ balance sheets. During the eurozone crisis, sell-offs in sovereign debt repeatedly dragged down profits and share prices in the banking sector, in turn raising the prospect of a further hit to the economy — a dynamic labelled the “doom loop”.
“The surge in home-government bond investment in Europe is a temporary response to excess market liquidity, in our view. We think this time is different than in the run-up to the European sovereign debt crisis starting about 2011,” said Cihan Duran, a credit analyst at S&P Global Ratings.
“If this turns out not to be true and the trend persists in Europe, overlooking sovereign risks could unleash a new ‘doom loop’ in the distant future, particularly where banks have built up extremely large exposures to sovereign debt,” he said.
The spread of the pandemic in March triggered a sell-off in global bond markets, which was particularly acute in the countries on the periphery of the eurozone. The European Central Bank helped to avert a new debt crisis with a €750bn emergency asset purchase programme, which was later expanded to €1.35tn in June. The central bank followed up with a fresh round of super-cheap loans to banks, resulting in a rush to borrow €1.3tn at negative rates.
While the injection of cash has increased the financial sectors’ ability to lend to households and businesses, much of it has ended up parked in sovereign debt, according to S&P. Banks in the EU do not have to hold any capital against their own governments’ bonds, which are considered a “risk-free” investment by regulators.
“We believe the central bank’s policies are unintentionally acting as an incentive for banks to add to their sovereign debt holdings. The ECB may take additional accommodative measures that might accelerate this trend,” the report said.
However S&P added that the huge run-up in government bond holdings is likely to unwind once the recovery from the Covid crisis kicks in.