Draghi: Sovereign debt included in stress test : Report

By Christopher Lawton

Bank holdings of government bonds will be tested among other debt categories in the European Central Bank's planned stress test next year, the bank's president said , but he warned that the larger debate over risk weights for sovereign debt holdings isn't up to the ECB
"Sovereign debt is going to be stressed like all other categories in banks' balance sheets," ECB President Mario Draghi said during a plenary debate on the ECB's Annual Report 2012 at the European Parliament in Strasbourg, France
Before the ECB takes over the supervision of banks in the euro zone in November 2014, it is conducting a review of the balance sheets of the largest euro-zone financial institutions in an attempt to bolster confidence in European banks and spur new lending to the private sector
The review will include a risk assessment, a balance sheet assessment and a stress test, conducted with the European Banking Authority
Mr. Draghi made a point to separate how the ECB will treat sovereign debt in its stress test from the debate over whether banks should have to back up their sovereign debt holdings with adequate capital While some have suggested that the ECB should have different risk weights on sovereign debt, Mr. Draghi said "this is not the task for us or for now."
"This is a global task that will be discussed by the Basel Committee at the proper time," the president added
Peter Praet, ECB executive board member responsible for the central bank's economics division, echoed Mr. Draghi's comments in an interview with the Financial Times, and argued that stressing the sovereign debt banks hold could lead banks to pare their use of central bank liquidity to buy more government bonds
"Appropriately treating banks' holdings of sovereign debt according to the risk that they post to banks' capital makes it unlikely that Banks will use central bank liquidity to excessively increase their exposure to sovereign debt," Mr. Praet said
The banks would be wary of the constraints placed on sovereign debt by the stress tests, he added
The ECB pumped more than 1 trillion euros ($1.38 trillion) of three-year loans into the euro zone's banking system about two years ago. These long-term loans helped avert a funding crisis for the banks. But they did little to stimulate lending to firms and households and were instead used primarily to buy government bonds
As a result, Mr. Draghi said Thursday that another long-term loan from the ECB would have to be geared and designed to increase the probability that it reaches real economy
In the roughly two-hour debate, the central bank president stressed that the ECB sees no sign of deflation in the euro zone, but countered that the region will see a protracted period of low inflation, justifying the central bank's November rate cut
"We are well aware of the downside risks that [low inflation] might entail. We stand ready to act and we are able to act," Mr. Draghi said