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The European Commission is considering a game-changing bank debt guarantee program, according to WSJ.According to sources cited by the report, the Commission “will propose a new scheme for pricing bank-debt guarantees that seeks to isolate the ‘intrinsic’ risk of a bank from the risk of its home-country government.”
The proposal would allow EU states to alter the price they pay to guarantee their debt by funding them jointly.
Banks have to pay a guarantee to borrow based on the risk associated with sovereign debt in their home country (which would have to do with the price of credit default swaps). This proposal would create a jointly funded “syndicate” to provide guarantees that would mitigate or even reverse the premium a bank in, say, Italy would have to pay to guarantee its debt over one located in an AAA-rated sovereign like Germany.
The report does not establish specific details about the program, but if it is sufficiently strong, it might go a long way in dissociating banks from their home sovereigns. So far, Italy and other peripheral European sovereigns are complaining that the guarantee program does not alter these prices significantly enough.
This would aim to stem the vicious cycle of bank fears and tightening credit conditions that have led yields on sovereign debt, particularly in the PIIGS, to skyrocket over the last few months.
Contraction in the funding markets has made European banks reluctant to lend, magnifying liquidity problems for solvent countries like Italy and Spain.
Unsurprisingly, the eurozone’s AAA-rated sovereigns are against providing joint guarantees on bank debts.
Read the full report here.
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