Pooling eurozone countries’ debts could cut risk — Study

FRANKFURT AM MAIN: A reform allowing eurozone countries to pool their debts could reduce risks to financial stability in the 19-nation single currency area, a study has found.

“This should be a stabilising force,” Central Bank of Ireland governor Philip Lane, who led the review for the European Systemic Risk Board (ESRB), told journalists in Frankfurt.

The study examines how an asset combining sovereign debts could work and whether investors would be interested.

Investors would be offered a product that bundled government bonds together, known as a sovereign bond-backed security (SBBS).

Buyers could choose between a ‘super-safe’ senior tranche accounting for 70 per cent of the value, a 20-per cent ‘mezzanine’ or medium-risk option, and a junior, higher-risk segment sized at 10 per cent.

ESRB simulations suggest investors holding the very safest debt would only lose money if one of the eurozone’s so-called ‘Big Four’ nations – France, Germany, Italy or Spain – defaulted on repayments at the same time as a number of others.

Even multiple smaller countries like Greece or Portugal defaulting would only affect holders of the junior and mezzanine tranches.

“By this process of diversification and de-risking, you’re expanding the potential pool of very safe assets, that’s a big potential prize,” Lane said.

The idea for pooling eurozone countries’ debt goes back to 2011 and the height of the eurozone crisis.

At the time, policymakers feared the so-called ‘doom loop’, where banks holding large amounts of their home country’s debt could get into financial difficulty if the value of the bonds fell as markets doubted the nation’s creditworthiness.

That might force the government to borrow yet more to rescue the banks – which in turn would further worsen the state’s credit.

One precondition for introducing the new assets would be changing regulations that currently prize sovereign debt as a very safe asset and penalise securitised (bundled) products, the study found.

In the wake of the financial crisis – in part sparked by securities bundling other types of debt like mortgages, whose value was hard for buyers to judge – regulators cracked down on the practice. — Reuters