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MILAN: Falling foreign demand for Italian government bonds is pressuring domestic banks to step into the breach, as they did back in 2011-2012. Yet they may find it harder to come to the rescue of the country’s debt this time around.

Foreign investors shed a net 33 billion euros ($38bn) in Italian government bonds in June, the Bank of Italy said last week, following a 25 billion sell-off in May, spooked by pledges to ramp up spending and unwind past deficit-curbing reforms from Italy’s anti-establishment coalition government.

When a similar trend developed during the eurozone crisis, home banks responded by gorging on high-yielding bonds that beefed up their revenues for years to come. The annual pace of increase in their domestic bond holdings soared to 20pc from an average of just 1pc in 2004-07.

But any hopes the banks will repeat that role may be frustrated because their situation has changed since then.

“Whether domestic financial institutions will continue to act as a steady (and potentially increasing) source of demand for sovereign (debt) ... remains a fundamental question for the coming months,” Goldman Sachs analyst Matteo Crimella said in a recent note.

To be sure, banks generally favour their own country’s bonds, a tendency known as “home bias”. Analysts also flag that they can be subject to “moral suasion” from authorities to help out in times of stress.

But “regulatory and supervisory changes, together with the risk of a deterioration in banks’ capital ratios/ratings owing to weaknesses in the sovereign market could, all together, raise the bar for domestic banks to step in as buyers,” Crimella said.

Published in Dawn, August 25th, 2018