ECB policymakers say no going it alone for government bond risk weightings

FRANKFURT (Reuters) - The euro zone should not go it alone and start assigning risk weightings to government bonds on bank's books unless such a move is internationally agreed, European Central Bank policymakers said on Tuesday.

Basel III banking regulations, which are being gradually phased in, treat all local-currency government bonds as risk-free, a rule that has been criticised particularly by German central bankers.

ECB executive Board members Benoit Coeure and Yves Mersch said that the proper arena for any potential discussions should be the Basel Committee and that common rules should then be applied locally.

"There are now suggestions for the appropriate fora, and in this case it would be the Basel Committee to look at the matter, and to stop a practice that could be called an illusion," Mersch told reporters on the sidelines of a conference in Frankfurt.

"It makes sense that assets are being weighted according to their riskiness and not according to conventions, which might not reflect reality," he said.

Mersch did not openly urge the Basel Committee to start such a discussion, but he hinted he would have no objection to such a move.

"I think it would be helpful if we face up to reality," he said.

Banks in some euro zone countries have snapped up bonds issued by their governments, leading to concerns that problems in the banking sector or in government finances could spill over to the other area as they become financially intertwined.

Coeure stressed that an international agreement was crucial on how to assess the risks linked to different assets.

"There is no reason a priori any particular kind of asset should be treated as risk-free by banks. That's a general principle that deserves to be supported," Coeure told TV station CNBC in an interview when asked about the treatment of sovereign debt.

"It is an important discussion, but it takes place in the Basel Committee for Banking Supervision. It is not a European discussion."

Mersch repeated that in a coming ECB asset quality review the bank would give government bonds a zero risk weighting, but he added that their treatment in a stress test later next year had not been decided yet.

ECB Governing Council member Jens Weidmann said on Monday that ending the preferential treatment of government bonds on bank balance sheets would contribute to a more stable financial system.

"Sovereign bonds should be adequately risk-weighted, and exposure to individual sovereign debt should be capped, as is already the case for private debt," Weidmann said.

Throughout the euro zone debt crisis, banks, particularly in Italy and Spain, have bought vast amounts of sovereign bonds. Italian banks held more than 400 billion euros ($540 billion) worth of government debt as of September, while Spanish banks held 300 billion, ECB data has shown.

Coeure repeated the ECB line that it is technically ready to make banks pay for the funds they deposit overnight at the central bank but that negative interest rates are just one of the tools in its armoury.

"We have a range of instruments that we would be ready to use if we see further risks to price stability materialising," Coeure added without specifying the other tools.

Coeure also said the central bank's main scenario is one where inflation will rise gradually, adding that the current inflation rate of 0.7 percent needs to be watched.

"We'll be monitoring very closely these numbers," he said of the low headline inflation figures.

($1 = 0.7404 euros)

(Reporting by Sakari Suoninen; Editing by Hugh Lawson)