The rise in bond rates in the euro zone revives the debate on “hellish loop” which links the health of banks to that of States. European establishments hold 4.3 trillion euros of sovereign debt, but their capital reserves are more solid than during the crisis of the 2010s.
In brief
- The rise in bond rates revives concerns about the solidity of European banks.
- Eurozone banks hold 4.3 trillion euros of sovereign debt.
- Their capital reserves and the diversification of their portfolios limit risks.
- Accounting protections can delay the recognition of losses, without eliminating them.
- Despite better resistance than in 2012, banks remain exposed to a lasting rise in yields.
How can public debt weaken banks?
Banks use government bonds as liquid assets and as collateral to obtain financing. They can also keep them in order to earn their interest. This proximity, however, becomes dangerous when investors doubt a government’s ability to control its debt.
In this case, bonds lose value and their yields increase. Banks that hold these securities may suffer losses, while their own funding costs rise. If the State must then support weakened establishments, its expenses increase further.
This loop can therefore develop in several stages :
- Investors sell the bonds of a government deemed riskier;
- Falling prices reduce the value of securities held by banks;
- Markets demand higher interest rates to finance these establishments;
- Banks limit their credits in order to protect their balance sheets;
- The economy is slowing and state tax revenues are declining;
- A possible bank bailout will further burden public finances.
This mechanism worsened the debt crisis in the euro zone between 2010 and 2012. The difficulties of States and banks then reinforced each other, with several support programs financed by public authorities.
France now finds itself at the center of concerns. The rise in its borrowing costs, its budget deficit and political tensions weighed on banking stocks. The shares of the three largest French banks fell 17% in six weeks.
Banks hold 4.3 trillion euros of debt
Eurozone banks held 4.3 trillion euros net of sovereign securities at the end of June. This amount has doubled since the previous debt crisis. However, it does not mean that their vulnerability has increased in the same proportions.
Capital reserves grew faster. The ratio between sovereign bonds and equity funds intended to cover losses fell from 2.7 in 2013 to less than 2.5 in 2026. The more this ratio decreases, the more banks theoretically have at their disposal to absorb a drop in the value of their assets.
Institutions have also reduced their dependence on their own country’s bonds. These national securities represented 41% of their sovereign portfolios in mid-2026, compared to more than 50% in 2013. This diversification limits the risk of a national fiscal crisis immediately hitting the entire local banking sector.
For the main French banks, exposure to national debt represents around 15% to 30% of their investment grade capital. For comparison, this ratio exceeded 100% for certain Italian banks at the height of the crisis in 2011 and 2012.
Simon Ainsworth, banking analyst at Moody’s Ratings, summarizes:
Banks are starting from a better position, but they are not immune.
The increase in yields can in particular make each new bond issue used by a bank to refinance more expensive.
Accounting protections do not eliminate risk
Banks have classified about 60% of their bonds as assets intended to be held until maturity. This proportion has tripled since the crisis. This accounting treatment allows them to not immediately record losses caused by a temporary drop in prices.
However, the protection disappears if an institution must sell its bonds to quickly obtain liquidity. Losses previously unrealized then become effective. Investor perceptions may also deteriorate, even if losses are not yet reflected in the accounts.
“While the situation is temporary, it should not strongly affect investor sentiment. If it lasts, it could weigh on the perception of risk”warns Maria Rivas, analyst at Morningstar DBRS.
The euro zone today has common banking supervision, stress tests and several intervention instruments from the European Central Bank. Institutions also display capital and liquidity ratios that exceed regulatory requirements.
These protections reduce the risk of an exact repeat of the previous crisis. They do not neutralize the consequences of a lasting increase in yields. Financing costs, the evolution of deposits and possible forced sales of bonds will therefore be the main indicators to monitor.
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