Bank’s Love of Debt Threatens ECB’s Plans

When Europe’s leaders set out in June 2012 to break the “vicious circle” between banks and sovereigns, they left rules for treating government bonds untouched, an oversight that may subvert their drive to prevent a recurrence of the debt crisis.

Under EU rules, banks can rate all debt issued by the bloc’s 28 national governments as risk-free, avoiding any increase in their capital requirements. This encourages so-called carry trades, whereby lenders borrow at low cost from the European Central Bank and plow the money into state debt that offers higher returns.

Twenty months after leaders pledged to change this behavior, banks hold more sovereign paper than ever. ECB President Mario Draghi said in December that when the Frankfurt-based central bank offered about 500 billion euros ($680 billion) of new low-cost liquidity two years ago, lenders used it “mostly to buy government bonds,” rather than for lending to stimulate the economy.

Bloomberg

This article is for general information purposes only. It is not investment advice or a solution to buy or sell securities. Opinions are the authors; not necessarily that of OANDA Corporation or any of its affiliates, subsidiaries, officers or directors. Leveraged trading is high risk and not suitable for all. You could lose all of your deposited funds.