The dangerous link between fragile banks and governments in the euro zone has been detailed in a new transparency report by the European Banking Authority (EBA).
The share of bonds issued by sovereigns under stress held by domestic banks increased markedly between December 2010 and June 2013, the report released late Monday said.
Following the financial crash of 2008, nations across the globe have been busy restructuring and rebalancing their economies. Substantial sovereign and bank debt led the euro zone to fall into a prolonged recession in 2011 as the extent of its problems became apparent.
The European Central Bank (ECB) has continued to pump liquidity into the economy via its long term refinancing operations. Under these schemes, struggling banks received cheap loans if they were unable to fund themselves through capital markets.
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With sovereign bonds - even from struggling euro zone governments - classed as risk-free under banking regulations, banks have bought government debt issued by their home countries. This gave them a higher yield on the cheap cash obtained from the ECB and helped lower the countries' borrowing costs.
However, many analysts warn that the link between weak governments and weak banks is creating a "doom loop" with the potential for banks and sovereigns to drag one another down during a crisis.
The report – which details the exposure from 64 European banks from 21 countries - shows that the net exposure of banks to sovereign debt fell 9 percent in 2011, but then rose 9.3 percent in the 18 months to June this year.
Ninety nine percent of the 23 billion euros of Greek government debt held by European banks was held by its domestic lenders, the figures from June show. That is an increase from a 67 percent figure in June 2010.
Spanish banks hold 89 percent of Spain's government's debt, according to the EBA, whilst Italy's banks hold 89 percent of Italian debt and Cypriot banks hold 84 percent of Cyprus' sovereign debt. German banks hold less German sovereign debt, down to 72 percent from 76 percent in 2010. Finnish lenders, in contrast, hold just 6 percent of their own government's bonds.
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