If the aim of governments is to restore the banking system to profit, they may unwittingly be succeeding quicker than they can have imagined.
Commercial banks are being completely rational by parking their much-prized liquidity at the short end. They buy three-year government guaranteed debt yielding something like 2.6% (using the UK as an example, but the same holds for the eurozone) and then place that with the central bank at a little over 1% – earning a risk-free return in excess of 150 basis points. This round-trip trade – funds raised with the help of governments and invested with another arm of the government – is a fresh take on intermediation.
Surely policymakers did not have this in mind as a business model for banks when they scrambled to offer them a financial lifeline?
Given issuance of $387 billion in two quarters, government-guaranteed debt has been understandably heralded as one of the biggest success stories in the capital markets of recent months.
From the moment government-guaranteed bonds trashed the yield curves of supranational, agency and second-tier sovereign borrowers, it became clear that the medicine would have side effects. These SSA names, alongside covered bond issuers, are struggling to compete with the huge supply – mostly at the short end of the curve – from guaranteed debt.