European Banks Face Growing Pressure From Sovereign Debt

The rise in bond yields in the euro area revives the debate on the “vicious circle” linking the health of banks to that of states. European institutions hold 4,300 billion euros in sovereign debt, but their capital reserves are stronger than during the crisis of the 2010s. Banks use government bonds as liquid assets and as collateral to obtain financing. They can also hold them in order to collect their interest. However, this proximity becomes dangerous when investors doubt a government’s ability to control its debt. In this case, bonds lose value and their yields rise. Banks holding these securities can suffer losses, while their own funding costs increase. If the state then has to support weakened institutions, its spending rises further.

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