UPDATE 1-Italy plans to offer guarantees on government bond derivatives

Mon Oct 21, 2013 10:29am EDT

By Giuseppe Fonte

ROME Oct 21 (Reuters) - A new system of guarantees Italy is planning to introduce will make it cheaper for banks to negotiate derivative contracts with the Treasury over government bonds, potentially increasing their ability to buy Italian debt.

The move is linked to new Basel III international banking rules that require lenders to hold more capital against their exposure to derivatives contracts.

The plan comes at a time when Italian banks are expected to slow down purchases of domestic bonds, making it more important for the Treasury to find foreign buyers for its debt. Italy is one of the world's biggest sovereign borrowers and has narrowly avoided being sucked into the euro zone debt crisis.

Under the new system, outlined in a draft decree linked to the budget law that parliament must pass by year-end, the Treasury and the banks will exchange cash sums on a short-term basis to guarantee their respective derivatives positions, based on their mark-to-market value.

The sums held as collateral will bear interest at money-market rates.

The measure is necessary due to "new financial regulations, (in order) to favour easier and cheaper sales of government bonds, through the reduction of the credit exposure of bank counterparties," said the draft document, seen by Reuters.

However, as it is a two-way system it will also protect the Italian state from counterparty risks, it said.

A Treasury official told Reuters the new system would help Italy issue debt denominated in currencies other than euros.

Italy's 1.7 trillion euros ($2.3 trillion) in government bonds included $19 billion issued in dollars as of Sept. 30. The Treasury last launched a dollar bond in September 2010.

"Such issues require hedging against currency risks through derivative contracts and would be too expensive without the system of guarantees," the Treasury official said in a note.

The draft bill said the new system was in accordance with International Monetary Fund recommendations, adding it had been recently introduced in Britain while Sweden had used it for a long time.

Analysts say Italian banks could be reluctant to increase holdings of domestic debt, already totalling 397 billion euros, because the European Central Bank is due to run an in-depth check of their balance sheets next year before taking over supervision of the sector from national regulators.

Italian think-tank Prometeia forecasts Italy's public debt next year will rise by 65 billion euros, hitting 134 percent of gross domestic product.

"It is difficult to imagine that the (Italian) banking system could absorb such an amount ... after absorbing around 100 billion euros in the course of 2013, actually it could lower the stock of government bonds it holds," the think-tank wrote in a report.

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