Search ForexCrunch

The long-term interest rate in the eurozone is now zero and the core eurozone countries’ long-term interest rate is now negative. However, holdings of public sector bonds or debt have not declined, even though, given the interest rate risk, it is becoming preferable to hold bank deposits rather than bonds. One possible explanation is financial repression, rules that force investors to hold public debt, according to economists at Natixis.

Key quotes

“Financial repression is the set of rules that force investors to hold public debt. This can involve for foreign central banks, rules that limit investment to risk-free bonds, with a virtual obligation to hold bonds from core euro-zone countries. For eurozone banks, the liquidity ratio (LCR) requires them to hold liquid risk-free assets, including in particular government bonds, which is one of the explanations for the high level of government debt held by banks. For insurers, the Solvency II rules (Solvency Capital Requirement, SCR) are based on an analysis of the risk of loss over a 12-month horizon, and therefore heavily penalise risky assets, driving insurers to buy risk-free bonds. Moreover, as euro funds have a capital guarantee at all times, they are also inevitably heavily invested in risk-free bonds.”

“Financial repression forces foreign central banks, banks and insurers to hold an abnormally high level of risk-free bonds. Without financial repression, either the ECB would be obliged to hold significantly more public debt or long-term interest rates would be higher , as they would have to compensate for the interest rate risk and the (even low) risk of insolvency on government bonds.”