december-23Economists are concerned that many European banks may face the same outcome as their governments. New data suggests that Europe’s banks are overexposed to the risk of a government failure, as overdependence on government bonds has put many of the Continent’s leading financial institutions in a risky position.

New figures from the European Central Bank indicate that Europe’s banks have been engaged in a large-scale purchase of sovereign bonds, which are seen by a large portion of the European economic community as a safer investment than lending. Economists believe this could create serious additional risks for banks.

Huw van Steenis, a senior analyst with Morgan Stanley, says “as lending shrinks and deposits grow, banks will invest the surplus in treasuries.” He believes that further increases in sovereign bond purchases are likely to occur, putting banks in Italy and Spain in a precarious position in which banks are affected by turbulent markets for sovereign debt, while governments are affected by the actions of European banks.

Mr van Steenis believes that the growing “feedback loop” between European banks mirrors that which grew in Iceland, Cyprus, and Ireland over the last few years, and warns that the fallout could be just as bad. Over the last two years, banks in Spain have increased their government bond holdings from 5 to 9.4 per cent.

Other banks have followed suit. In Italy, banks have increased their sovereign bond holdings from 6.4 per cent to 10.3 per cent. In Portugal, from 4.6 per cent to 7.8 per cent. Economists are concerned that the rapid surge in government bond holdings puts the Continent’s financial future at risk.

Over the next year, European authorities will perform “stress tests” of several major European banks. Sovereign debt holdings currently do not adjust risk under the EU’s CRD IV rules.

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