Sunday, February 21, 2010
Why European banks hold so much Greek government debt
European financial institutions have $235 billion worth of claims on Greek debt, most of which is thought to be in government bonds. Why do they hold so much Greek government debt? Because the only category of bank asset treated more kindly by the Basel rules than asset-backed securities is government debt, which has a zero risk weight. i.e., no bank capital need be used to buy a government bond. This appears to be the reason that the possibility of Greek default has led to fears of another banking crisis. Digging deeper, the Basel rules rank debt according to the issuer's credit rating. Yet again the big ratings agencies are to blame. It's time to remove their regulatory role.