By Francesco Guarascio
BRUSSELS (Reuters) - European Union finance ministers will discuss putting a cap on banks' exposure to sovereign debt when they meet next week, an EU document said, confirming what officials told Reuters earlier this week.
EU countries have been debating for months whether to revise the status enjoyed by public debt which holds down government borrowing costs but which during the euro zone financial crisis added to a "doom loop" of dependency between states and banks.
Sovereign bonds are treated as risk-free and are exempt from limits imposed on bank holdings of corporate or household debt. EU countries have been cautious about changing that treatment for fear of affecting markets and banks' financial stability.
Under pressure from Germany, the Dutch presidency of the EU has decided to put the issue for the first time on the agenda of a meeting of EU finance ministers.
"Structurally elevated home sovereign debt holdings will (...) amplify the risk that when a sovereign defaults a systemic bank crisis will occur," the Dutch presidency of the EU said in a document preparing for the talks in Amsterdam on April 22-23.
Berlin wants to reduce euro zone banks' risks before embarking on banking projects which would increase the cost-sharing of rescuing failed lenders, such as a common backstop for the euro zone bank fund or a joint insurance scheme for deposits in euro zone banks.
Italy and France have also prepared a joint document ahead of the meeting to urge propping up the recently established euro zone bank fund (Single Resolution Fund).
One option the ministers will discuss next week is a limit on maximum exposure to a single sovereign issuer, the document said, and a second option is to change the risk-free status of sovereign bonds introducing "a risk weight calibration based on credit risk", or "a flat risk weight floor independent of the credit risk of a single sovereign".
Another possibility is to impose on banks both caps and higher costs to hold sovereign bonds, the document said.
It also warned against the risks that regulatory changes could bring to sovereign bond markets and said banks would need a long transitional phase to adapt to caps, for example "by holding these excess sovereign bonds to maturity".
A further two options envisage no change to existing rules and greater disclosure requirements, obliging banks to show their sovereign exposures.
The Basel Committee, a body of banking supervisors from nearly 30 countries, is also discussing the issue and the Dutch document suggests that the results of EU finance ministers' discussions could contribute to the Basel process.
(Editing by Louise Ireland)