MNI EXCLUSIVE: End Of Zero-Risk Govvies May Harm EZ Bond Mkts

--Ending Preferential Zero-Risk Bonds Not Key To Ending Risk - Source

--Italian Banks In Line For Hit If New Bank Holding Rules Adopted

By Slivia Marchetti

     ROME (MNI) - Ending the preferential treatment of European government

securities held by banks is not key to systemic risk reduction and may

destabilise bond markets across Europe, a senior Italian government official

told MNI.

     "This is a non-problem, thinking that the link between sovereign debt and

lenders is a crisis-trigger. Italy's banks have suffered in the past due to the

economic downturn and not because of the amount of bonds on their balance

sheets," argued the source.

     "Above all, adopting tighter rules, or placing a cap on government

securities held by banks, would only be counterproductive. The risk is to hinder

the natural functioning of bond markets across the whole eurozone," he warned.

     European regulators have been considering the problem of banks sovereign

holdings since the eurozone debt crisis and, ahead of the creation of a full

banking union, they are looking for solutions.

     Other concrete, more domestic threats to ending the so-called 'zero-risk'

sovereign era include making debt issuance tougher, as government bonds would

have a risk linked to a country's debt rating, thus rendering them less

appealing on the market.

     --HITS BANK LENDING

     Italian banks would also be required to put aside capital proportional to

the degree of their exposure, depriving the real economy of crucial capital

flows at a time when the economy is finally gaining some momentum.

     The source noted that the benefits of tighter macro-prudential rules on

sovereign exposure remained uncertain, but that there would be one clear

outcome; it would cause "wide and unpredictable" movements of capital within the

European bond market.

     "Sovereign exposure has always been an excuse not to pursue along greater

burden-sharing at European level, but public debt reduction must be dealt with

at national level and not tackled with rules set at a higher European level,"

said the official.

     The current Rome government actually believes that in certain situations,

banks' sovereign exposure may, in fact, act as a buffer, stabilising against the

risk of financial contagion.

     Placing caps on bank sovereign bonds holdings, especially in times of

system-wide tension, can end up fuelling crises and increasing market

speculation, therefore causing exactly what the regulation aims to avoid, argued

the source.

     "If any country faces a sovereign debt crisis, this expands to the economy

and by extension to its banks. It's not the other way round. The drastic

restructuring of any large public debt has inevitable repercussions on the

entire eurozone, just look at what happened in Greece," the source said.

     --ITALIAN IMPACT

     Italian banks have large holdings of sovereign bonds in their portfolios,

among the highest levels in the eurozone. Their sovereign exposure totals around

E400 billion, amounting to 15% of total assets as opposed to an average 6% in

the rest of Europe.

     In recent years, the outgoing Democrat-led government has succeeded in

rallying support, especially among other southern debt-ridden members such as

Portugal, Greece and Spain, where ending 'zero-risk' on sovereign holdings would

have similar negative impact.

     The government source expressed confidence that the new German government,

which has already opened-up to a new, less-austere EU path, could also

eventually soften its stance on risk reduction.

     Despite Italy's current political turmoil, whichever Italian party or

coalition governs will continue the crusade against tighter sovereign exposure

rules, the source said.

--MNI London Bureau; tel: +44 203-586-2225; email: les.commons@marketnews.com

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