Stricter capital requirements for investing in EU government bonds as a means of creating a more stable financial system

In the wake of the European debt crisis, it has become clear that government bonds may actually be a risky form of investment. The Basel Committee and the Bundesbank have therefore opened an intense debate as to whether banks investing in EU government bonds should be subject to regulatory capital requirements in the future. Currently, banks do not need equity capital when investing in sovereign bonds. Waiving this exemption privilege would result in an additional Tier 1-capital requirement of 3.34 billion euros for the German banks studied here. This represents just under 1.8 percent of available Tier 1-capital. For French banks, the calculated capital requirement is 3.52 billion euros (a good 1.2 percent), while Swedish banks have a requirement of an additional 80.6 million euros (0.14 percent). Raising these funds is not likely to cause any major problems for banks in these countries. It is an entirely different matter for Greek banks, however. The capital requirement in Greece is relatively high at almost 1.8 billion euros or almost nine percent of existing Tier 1-capital. Despite its modest impact on the leverage on banks' balance sheets, a regulatory obligation to finance investments in EU government bonds with some equity capital would be very welcome. The ratio of equity to total assets would improve, at least slightly, and the reform would probably loosen up the close link between bank risks and sovereign debt in the longer term. Both would help achieving a more stable financial system within Europe.