European banks grapple with weak bonds

Standard banking practice was for these banks to post as collateral their home market government bonds, which were once considered liquid, risk-free investments – much like US Treasury bonds.

If, as was the case with Ireland and Greece, lenders stop accepting these bonds or start demanding more bonds to reflect their lower value, these banks may no longer be able to access funding. daily life which is their lifeblood. This is what happened during the crisis of autumn 2008, when the banks stopped lending to each other, causing the markets to stall and causing the government to bail them out or risk the bankruptcy of the most weak.

“You could ask the chief financial officer of a lending bank to say, ‘Look, I just don’t want to take on this credit risk,'” said Marcello Zanardo, European Bank analyst at Sanford Bernstein. “We’re not there yet, but it’s not impossible to get there.”

What worries many banking analysts – and surely the banks themselves – is that, in an investor panic, this could happen sooner rather than later.

One possibility is that LCH.Clearnet, the London clearing entity that in a transaction between two banks or other counterparties assumes the risk if the transaction fails, may start demanding more collateral if those securities continue to lose value.

This would mean that an Italian or Spanish bank issuing a government bond to secure a short-term loan or repurchase agreement would see that bond written down by its clearer, forcing it to issue more bonds – or accept less debt. money to finance its operations.

According to LCH, once the spread between, say, a Spanish or Italian government bond and a benchmark AAA bond index exceeds 4.5%, the issuer is subject to a reduction. At this point, the borrower is forced to post more government bonds as collateral, and if the spread continues to widen, they are eventually forced out of the market.