German Central Bank President Criticizes Government Debt Financing By Commercial Banks

Sources

First article is about the article by the German Bundesbank President titles “Can the 'disastrous nexus' of banks and governments be controlled? No.” (1) published on 10/24/2013.

The second article is by Mr. Jens Weidmann himself published as a “central bankers’ speeches” by Bank for International Settlement (BIS) titled “Stop  encouraging banks to load up on state debt” (2) published on 10/1/2013 in the Financial Times.

An Incestuous Relationship

In the age of fiat money and even before that, governments have frequently abused central banks to finance their deficits. It is one of mankind’s scourges. E.g. Germany in the first half of the 20th century, or several Latin American countries in the 20th century. Or take the irresponsible Fed chief and Harvard economist Ben Bernanke.

Salient Excerpts

Excerpts and comments (emphasis added):

“Loans to sovereign governments are granted favored status by bank regulations and indeed are promoted by them, as having no risk-to-one-borrower limits for example, as well as very low or zero capital requirements, and being often referred to as "risk-free." But in fact nothing is more common in financial history right up to now than defaults by governments on their debt. There have been about 250 defaults on sovereign debt since 1800, including widespread government defaults in the 1980s and the 21st century defaults by Greece and Argentina.” (1)

“The answer is apparent: the regulators who write the rules are themselves employees of the government. They are hardly likely to limit or criticize banks' lending to their own employer.” (1)
[This would certainly apply to the so called Basel Accords. I blogged here about it.]

“The archetypical case is the establishment of the Bank of England in 1694. The deal was straightforward: the bank got its charter by promising to lend money to the government, much needed to finance King William's wars at the time, and the government would give the bank profitable special privileges, especially a monopoly of issuing currency. (It didn't hurt that the Royal Family was among the shareholders of the new bank.)” (1)

[This sums it up quite well!]

“Preferential regulatory treatment makes it highly attractive for financial institutions to invest in

government bonds – and those of their home countries in particular. During the crisis, this

has become more attractive still. The share of euro-area sovereign bonds in total bank

assets in the eurozone increased over the past five years by one-third – from 4 per cent to

5.3.” (2)

[5.3% does not sound like much. I was surprised Mr. Weidmann quoted such a low number.]

“Large sovereign bond exposures might also harm the real economy. Rises in sovereign risk

are transmitted into reduced bank lending. Banks that were highly exposed to strained

European sovereign debt have reduced their lending to the private sector.” (2)

[This well known crowding out effect is not a matter of “might” it is a fact.]

“Thus, the current regulatory treatment is incompatible with the principle of individual

responsibility; the market interest rate no longer reflects the riskiness of the investment. I am

aware that banks as well as governments are afraid of rising funding costs as a result of

ending the regulatory privileges afforded to sovereigns.” (2)

[Well, Mr. Weidmann was until recently an economic advisor to chancellor Merkel.]

“The current regulation’s assumption that government bonds are risk-free has been dismissed

by recent experience. The time is ripe to address the regulatory treatment of sovereign

exposures. Without it, I see no reliable way of breaking the sovereign-banking nexus. ” (2)

Sovereign Debt Financing By Central Banks

Unfortunately, Mr. Weidmann did not say anything about this subject.