01-AprilMany of Europe’s banks are ‘loading up’ on sovereign debt, according to recent data released by the European Central Bank. Public sector debt accounts for 5.8 per cent of European bank assets, fuelling concerns among economists about stability.

Sovereign debt accounted for approximately 4.3 per cent of European bank assets in January of 2012. The 1.5 per cent increase over just two years has prompted leading economists to voice concerns that the increase in sovereign debt holdings could lead to a dangerous interdependency between European banks and governments.

Data from the European Central Bank indicates that most of the increase is related to banks’ holdings of public debt. Eva Olsson, Mitsubishi UFJ Securities director of credit strategy, notes that the idea that certain banks are “too big to fail” has yet to disappear from the Eurozone.

Mediterranean economies have experienced the biggest increase in sovereign debt holdings. In Italy, 10.2 per cent of all bank assets were government debt, according to statistics from February. In Spain and Portugal, government debt makes up 9.5 and 7.5 per cent of all bank holdings, respectively.

Perhaps most worrying is the situation in Slovenia, where government debt makes up 13.9 per cent of banking assets. Economists believe that the dependence could result in a ‘downward spiral’ in the event that a major lender failed or a country’s credit rating was adjusted downwards.

Under the Basel II framework, which regulates the European banking industry, all national regulators are allowed to consider sovereign debt risk-free. Banks are not required to hold any capital against government debt in order to comply with their regulatory obligations, unlike the requirements for consumer or business debt.

Worryingly, the increase in sovereign debt holdings has not only affected Europe’s weakest economies. German banks now hold 4.6 per cent of their assets in the form of government debt, up from 3.5 per cent. In France, 3.6 per cent of bank assets are in the form of sovereign debt.

Ms Olsson believes that Europe’s banks should start acting “as real banks” now and end the cycle of sovereign debt trade. The Eurozone’s banks should “lend money to companies and so on” instead of simply acting as investment institutions.

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