A European Safe Asset to Complement National Government Bonds

Abstract

This paper expands the growing literature on common safe assets in the context of the euro area financial system by employing credit risk simulation techniques to investigate the properties of different safe asset models and their impact on national bond markets. The paper explores in particular the E-bonds model, whereby a supranational institution would raise funds in the markets and provide bilateral senior loans to Member States corresponding to a fixed proportion of GDP, complementing the issuance of national government bonds, without risks of mutualisation. The main findings are that E-bonds could reach a volume of 15 to 30% of euro area GDP with a high degree of safety while becoming the reference safe asset for the banking sector, capital markets and monetary policy operations in the euro area. As regards the impact on remaining national bonds, such volumes would be consistent with Germany maintaining its top credit rating. The average funding costs of Member States would remain broadly stable, while marginal funding costs would tend to experience limited increases, which should enhance market discipline. * The opinions expressed in this paper are the authors' and do not necessarily correspond to those of their institutions of affiliation or the European Commission, to which they should not be attributed. The authors are grateful to Marco Buti and José Leandro for extensive discussions on, and encouragement for, our work on the concept of the European safe asset and possible constructions; to Dris Rachik for his statistical support; and to Sam Langfield,Álvaro Leandro and Jeromin Zettelmeyer for the close interactions and joint effort to advance on this topic, and for sharing the calculations underlying their respective work. We are also indebted, for useful discussions, comments and suggestions, without implying their endorsement, to our colleagues at the European Commission,

Fiscal and financial conditions for a stronger euro area

“…8. The calculations regarding the Leandro/Zettelmeier (2018b) proposal have been updated with more recent market information in Giudice et al (2019).…”

Creating a Euro area safe asset without mutualizing risk (much)

“…As in the SBBS approach, an intermediary would hold a portfolio of government debt and issue securities-"E-bonds"-backed by this portfolio (Monti 2010;Zettelmeyer 2018a, 2018b;Giudice et al 2019). Unlike SBBS, however, E-bonds would be issued as a single tranche.…”

“…Policy proposals to create a common public debt security for the euro area originated in the early days of the euro area crisis and have seen a recent resurgence (Brunnermeier et al 2017, ESRB 2018 Commission 2018, Leandro and Zettelmeyer 2018a, 2018c, Giudice et al 2019. They respond to two main motivations.…”

“…We also followGiudice et al (2019) in assuming that countries cannot be forced to borrow more from the Ebond issuer than their current outstanding debt, implying that the GDP-based rule is in fact a two-limit rule, with outstanding government debt securities constituting the second upper limit. However, the second limit turns out to be binding for only two countries: Estonia and Luxembourg (seetable 2).…”

Banks' home bias in government bond holdings: Will banks in low‐rated countries invest in European safe bonds (ESBies)?

“…To ensure that bank capital adequacy regulations for securitized European safe bonds (ESBies) are the same as those applied to direct holding of government bonds, the European Commission (2018) proposed a specific regulation on capital adequacy neutrality, which was adopted by the European Parliament (2019). Alternatives to the creation of ESBies include a supply of E-bonds, that is, bonds issued by a supranational institution that would lend the proceeds to Member States on a senior basis (Giudice, de Manuel, Kontolemis, & Monteiro, 2019;Leandro & Zettelmeyer, 2019).…”