European Sovereign Debt, Again No Risk Asset

Speculations about how European financial authorities would finally consider sovereign risk, fiscal assets and subprime loans have been rolling over banking sector in the last months. The main reason was the possibility of using different valuation formulas to each country’s public debt. Ofelia Marín-Lozano, 1962 Capital Sicav’ CEO wondered recently in one of her notes if Spanish or Italian public debt could get an appreciation lower than German, consequently increasing capital needs of national banks loaded with those countries’ debt.

“It seems highly unlikely. To change held-to maturity public debt portfolio would not make sense: sovereign states do pay until proven otherwise; furthermore, other partner countries could feel discriminated”, she answered.

On Wednesday the European central bank confirmed this argument by recognising that the majority of public debt will not be punished in the financial system stress test to be performed at the end of present year.

The resolution could not be very different since the Bank of International Settlements which is the bank among banks fixing Basel rules, treat all sovereign debt with equal standards. In spite of rumours about hypothetical leakings, the reality is that ECB’s president Mario Draghi sent a letter to Sharon Bowls, Chairwoman of the Committee on Economic and Monetary Affairs belonging to European Parliament, on January 10th, saying that “is not foreseen that held-to-maturity sovereign exposures portfolios will be marked-to-market”.

That means that European entities will not be forced to provision additional capital to cover this point and therefore pass the test. However, available-for-sale exposures will be penalised. They represent a minor part of sovereign debt so that the ECB would be reducing its inicial requirements.

According to Bankinter analysts, ECB’s decision is “reasonable” because it agrees with global accounting rules and which is more important, would allow Spanish banking sector to generate gains. Spain’s entities feared the central bank’s resolution basically  because they hold a sovereign held- to maturity portfolio of € 260,000 million. In the case the ECB had decided to apply a 12% discount, the “hole” would exceed € 31,000 million.

Furthermore, Draghi suggested in the letter that further details concerning the stress test will be announced in late January or early February. The ECB could fix a minimum base capital ratio of 6% for stress tests, which is not very far from 5% of  2011 European Banking Authority’s. “Behind this increasing of standards is the ECB’s desire to give the tests more credibility”, Santander’s expert Fernando Marín says. The Asset Quality Review (AQR) which will be performed previously in 2014 will fix a minimun capital ratio of 8%.