ANOTHER day, another U-turn in the Eurozone – although this time it
may mark the Spanish government’s acceptance of the huge problems in the
country’s banking system.
The Spanish government announced on Monday that it will be injecting
Bankia, the country’s third largest bank, with up to €10bn (£8bn) in
capital, using the state-backed FROB bank restructuring fund, despite
previously dismissing the possibility of doing so. Given the timing of
the announcement – on the same day that Greece went through political
upheaval – one can’t help but think that the Spanish government
harboured some hope that the declaration might fly under the radar.
Given the size of Bankia and the implications of the bailout such
hopes were misplaced. Bankia has one of the largest exposures to the
country’s bust real estate and construction sector at €38bn, of which
€18bn is considered problematic. It was also the poster child for what
now looks to be the laudable but ultimately doomed structural reform of
Spanish banks that took place last year. It is the largest of the
consolidated cajas (Spanish regional banks) and the problems on its
balance sheet highlights how little the banking consolidation solved.
Taxpayer-backed bank bailouts are never ideal, but if Spain goes down
this road, getting the correct mix of support and strong conditions is
vital. The most likely form of any future intervention is the widely mooted
“bad bank” plan and the first question, as always, is where will the
money come from? Currently Spanish banks have €54bn in provisions
against €136bn in doubtful loans. The latter number looks set to
increase as conditions worsen, particularly with much larger falls in
real estate prices expected – we predict that provisions will need to be
at least doubled. Bankia is likely to be only the tip of the iceberg,
both in terms of problems in Spanish banks and the use of public funds.
Securing private funding will be near impossible, leaving two sources
of public funds: the Spanish FROB bank restructuring fund and the
EFSF/ESM Eurozone bailout funds. The FROB in theory has a lending
capacity of €99bn, but most of the cash must be raised by issuing debt,
with only €18bn directly guaranteed by the state. There are questions
over whether the fund could borrow cheaply if it backed a “bad bank”,
potentially leaving the majority of the gap to be filled by Eurozone
bailout funds.
Given the growing political opposition to both the bailouts
themselves and the austerity conditions which they come with, such a
large transfer of European funds could be political dynamite in Europe.
The main concern is the huge moral hazard associated with bailing out
banks – this was a trend which many in Europe hoped had been bucked,
and opening it up again would damage Eurozone credibility. The aim is to
encourage banks to start lending and aiding economic growth again but
this is notoriously difficult – who’s to say they won’t keep hoarding
funds over wider fears of a Eurozone break-up?
The most important part
of the process will be an honest external valuation of these doubtful
loans, something which Spain and the Eurozone have shied away from
before. Any funds must therefore come with clear conditions. The key to
enforcing these will be allowing some banks to fail or be wound down. In
the end, many of these banks have unworkable balance sheets in the
aftermath of the housing bust. This will be the clearest signal to show
that public funds are not being used to solely prop up banks, that only
viable businesses will survive and that the Spanish government is
committed to reform.
In many ways the use of public funds to help Bankia could be a
turning point for the crisis in Spain. The good news is that the Spanish
government finally accepts the need to tackle the wider problems with
its banks, presenting an opportunity to flush out the sector once and
for all. On the other hand, it significantly increases the likelihood of
taxpayer-backed Spanish and Eurozone funds being used to bail out banks
once again. What’s clear is that, until the problems are fully
addressed, the Spanish banking sector malaise will still threaten to
engulf the whole economy and potentially drive the country into a full
bailout programme.
