RISKY BUSINESS

One country’s banks finally admit the obvious: Governments can go bust

Obsession
Future of Finance
Obsession
Future of Finance

In European financial markets, government bonds hold a special status. According to accounting rules, EU sovereign debt is considered risk-free. That is, banks don’t need to set aside extra capital in case these bonds go bad before they’re due, whether issued by Germany or Greece—yes, even Greece!

It wasn’t that long ago that European markets were plunged into crisis and some euro-zone governments succumbed to international bailouts. Government bonds from these countries proved very risky—indeed, Greece took a “haircut” on its debt, saddling holders with losses (and forcing the Cypriot financial system into a bailout of its own).

Still, EU rules state, somewhat absurdly (paywall), that banks don’t need to hold capital against holdings of EU government bonds. European banks are currently stuffed with more than €2.6 trillion ($3 trillion) in EU sovereign debt. Since the crisis, the zero-risk weighting of these bonds has been extensively debated, but little to nothing has been done about it.

Except in Sweden.

In 2015 Sweden told its banks to drop the standardized models that considered EU sovereign bonds risk-free and instead use their own internal models to assess the riskiness of a nation’s debt. The rule has now gone into effect, and the first results came out recently. SEB, one of Sweden’s largest banks, said that its “risk exposure amount” needed to increase by 9 billion kronor ($1.1 billion) in the first half of the year to reflect there was a chance it could suffer losses on its sovereign debt holdings.

Why haven’t the rules been changed elsewhere? Namely, because the practice is good for governments, since it make banks ready buyers of their bonds. Introducing a risk weighting higher than zero would increase capital requirements, lead banks to avoid less creditworthy sovereign bonds, and raise financing costs for governments. Greece, which still relies on international bailout payments, is reportedly planning to issue new bonds soon. Does it make sense that buyers can deem this debt “risk-free?”

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