Did Mario Draghi Axe New Banking Regulations on Sovereign Debt?

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Mario Draghi, the head of the European Central Bank, denied that he blocked a recommendation that would attach levels of risk to government debts held by eurozone banks, Reuters reports.

According to Der Spiegel, a German news magazine and media outlet, the European Systematic Risk Board presented Draghi with a series of measures that would redefine how sovereign debt is treated on the balance sheets of European banks. Currently, it is treated as a completely risk-free asset, meaning that banks have piled up on government debt in order to make their holdings more attractive to investors and regulators alike. This is in line with the latest set of banking regulations called Basel III.

The ESRB’s changes would have made government debt more like corporate debt in medium-term time frames, allowing banks to hold only up to a certain percentage of their assets before restrictions kicked in. If too much sovereign debt is held, then risks would have to be attached to the asset. Der Spiegel reports that these regulations were handed back by Draghi to the board’s executives for revision, meaning that Draghi found them unacceptable and that the proposed changes were not something he wants to see implemented in the eurozone.

On Monday, the European Central Bank responded by saying that no such action took place. According to the bank, Draghi never blocked the motion, nor did he encourage officials of the board to revise their recommendations. However, uncertainties persist over exactly what happened. Somewhere along the line, there was either confusion over what transpired, or one of the two accounts is incorrect.

If government debt is allowed to continue to be treated as risk-free, it means that many eurozone banks will be able to stockpile huge amounts of sovereign debt on their balance sheets, especially with interest rates being so low. In effect, this acts as a form of quantitative easing, as banks can use funds from the ECB to purchase government debt from various countries across the region. Additionally, it constricts the amount of funds available to businesses, as capital that would previously be lent out is instead placed in the hands of governments.

Adding risk to government debt would rein in that practice, but it may undermine confidence in the region’s governments. While some countries like Greece and Spain may need to have risk values assigned to their debts, the ECB has repeatedly said that it  is committed to keeping the countries solvent at any cost; anyone doubting that needs only to look at the massive bailout programs that have occurred as evidence that the bank means what it says. Either way, the central bank is facing a tough choice, and Der Spiegel’s report only serves to complicate matters even further.

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