Kopafbeelding publicaties CPB

A Review on ESBies - The senior tranche of sovereign bond-backed securities

CPB Background Document, 5 June 2018

Safe assets, assets with low risk and high liquidity, are the cornerstone for modern financial systems. The biggest holders of safe assets are banks, which need to hold safe assets to meet capital and liquidity requirements. Safe assets also provide high-quality, liquid collateral for banks’ repo transactions. Besides, safe assets provide benchmarks for the price formation of other financial assets.

The supply of safe assets in the euro area is lower than that in the United States, which is considered to impair financial stability in the euro area. First, the scarcity of safe assets exacerbates capital flows to safe countries during a crisis. Second, European banks increased their holding of domestic government bonds during the crisis., that intensified the relationship between banks and governments. To resolve these vulnerabilities, economists have made different proposals to create a new safe finance instrument. The new safe assets should achieve two goals of increasing the supply of safe assets, and weakening the bank-sovereign nexus.  

This background document provides a review on proposals for European Safe Bonds (ESBies). ESBies are the senior part of sovereign bond-backed securities (SBBS) in which government bond yields from all euro-countries are divided into a senior and a junior part. The design of ESBies does not assume risk sharing across countries. Our review suggests that ESBies might increase financial stability in the euro area, by increasing the supply of safe assets and weakening the sovereign-bank nexus.  

The regulation on sovereign exposure needs to be adjusted to create a level playing field for ESBies. In May 2018, the European Commission proposed an enabling regulatory framework for the development of sovereign bond-backed securities, which would allow a neutral treatment of ESBies relative to sovereign government bonds. This would pave the way for the demand of ESBies by banks and insurance corporations. 

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