Bloomberg News

BIS Sees ‘Severe’ Problems If Sovereign Debt Isn’t Risk-Free

October 03, 2011

(Updates with comments from Caruana in second paragraph. See EXT4 <GO> for more on the European debt crisis.)

Oct. 3 (Bloomberg) -- Bank for International Settlements General Manager Jaime Caruana urged European leaders to step up efforts to solve the region’s sovereign-debt crisis to prevent a further deterioration of the banking system.

“We need to urgently and forcefully regain fiscal credibility and take the necessary actions to restore the risk- free status of sovereigns,” Caruana said at a conference in Vienna today. “The implications of not having sovereigns as risk-free are very severe, they will materialize in many areas,” including banks’ capital requirements.

Concern that European officials will fail to contain the region’s debt crisis as the U.S. recovery falters wiped more than $9 trillion from the value of global stocks last quarter. Europe’s finance ministers are meeting in Luxembourg today to weigh the threat of a Greek default, assess ways to shield banks from the possible fallout and consider a further boost to the region’s rescue fund. They’ll also tackle the question of how to improve economic and fiscal governance.

Caruana, a former council member of the European Central Bank, said the “key challenge’ for European authorities is to break the ‘‘feedback loop between weak public finances and fragilities in the financial system.’’

‘Major Fault Line’

‘‘The loss in market confidence in sovereigns particularly in the euro area has opened up a major fault line for financial systems,’’ Caruana said. ‘‘The problem is that these new situations tend to materialize in funding difficulties, funding shortages, which again are something that we have to look at carefully because they are very risky.’’

Government bonds are classified as assets with no risk under the global bank rules set by the Basel Committee on Banking Supervision. That means banks don’t have to set aside capital for them as they have to do for assets such as loans or corporate securities. This fact, which isn’t changed under Basel’s new set of rules, contrasts with credit-default swaps signaling the probability of a Greek sovereign insolvency at more than 90 percent.

ECB Governing Council member Ewald Nowotny, speaking at the same panel discussion as Caruana, said a nation using the euro isn’t ‘‘free just to print money” when needed.

“That means a single country is seen more like a corporate than like a traditional country with its own central bank,” he said. “This is really a game change that we have seen and that hasn’t been fully understood by politicians and by other players.”

--Editors: Simone Meier, Jeffrey Donovan

To contact the reporters on this story: Boris Groendahl in Vienna at bgroendahl@bloomberg.net; Gabi Thesing in London at gthesing@bloomberg.net

To contact the editors responsible for this story: Craig Stirling at cstirling1@bloomberg.net; Angela Cullen at acullen8@bloomberg.net


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