France’s 24-Year Yield High Puts European Banks’ Sovereign Exposure in Focus

France’s 10-year government bond yield climbed to a 24-year peak on Oct. 22, putting the scale and accounting treatment of European banks’ sovereign holdings in focus as bond prices came under pressure.

At 11:30 a.m. ET (15:30 UTC), the French 10-year government bond yield reached 5.07%. Government bonds serve banks as investments and as liquid assets they can use to support funding, but their market prices generally fall when yields rise.

EU/EEA banks held €4.540 trillion in gross sovereign exposures as of June 30. After short positions were deducted, direct exposure stood at €4.327 trillion. Home-country government debt represented 43% of those exposures, while debt from other EU/EEA governments accounted for 33%.

The accounting treatment of those holdings can affect when market movements appear in reported values. About 59% of EU/EEA sovereign exposures were classified at amortized cost, so their reported values do not change with every market-price movement. If a bank has to sell bonds to raise cash, however, it can realize losses as prices decline.

The EU/EEA banking sector’s Common Equity Tier 1 ratio was 16.1% in the second quarter. Over the six weeks through Oct. 21, European bank shares lost 10%; shares of France’s three largest lenders fell 17%.

Higher yields can increase income on bonds banks buy later, while raising refinancing costs when existing bank debt comes due. France’s borrowing-cost pressure has also appeared in the yield premium on French bonds over German debt.

“Banks come from a better starting point but they are not immune,” said Simon Ainsworth, senior banking analyst at Moody’s Ratings. Funding costs, deposit flows and any forced bond sales could help show whether the pressure is feeding through to bank balance sheets.