Full rebuilding of Spain’s banks crucial for nation “living on borrowed time”

Fund managers are demanding a “credible recapitalisation of Spanish banks” as sector analysts admit the market believes Spain is “living on borrowed time”.

Darren Williams, senior European economist – global economic research at AllianceBernstein, says the recapitalisation is necessary, but will not be enough to stabilise markets.

Bank analysts at Credit Suisse estimate the sector’s saviours will need to commit additional provisioning of just over €150bn – which is likely to translate into a capital shortfall of €50bn to €70bn, or 4.5% to 6.5% of GDP.

Last week Madrid was called upon by the European Commission to spell out exactly how it would bail out Bankia, with €19bn.

Madrid wanted to recapitalise Bankia by issuing sovereigns to Bankia, in return for an equity stake. Bankia would then use the bonds to borrow from the ECB, but the ECB reportedly rejected this.

Williams says much of Spain’s banking system is “in tatters”, and “unlike Ireland, the Spanish government has been very slow to do deal with this”.

Assets are flying out of Spanish banks at speed.

Williams notes Spain’s banks have €3.7trn assets, and the economy they help finance is €1.1trn – 11% of Eurozone output and almost twice as big as Greece, Portugal and Ireland combined.

“The government now realises that a comprehensive recapitalisation of its banks is overdue. To this end, it has commissioned two independent reviews and these are due to report at the end of June. Late last year, AB credit research estimated that the full cost of recapitalizing the Spanish banks could be as high as €70bn to €100bn, or 7% to 10% of GDP.”

If Madrid needs external assistance, Williams says the present and future bailout funds could lend it money to rebuild Spain’s banks – though Madrid is reluctant to take this route, preferring the bailout fund to do the work itself.

“For markets, a direct recapitalization would clearly be the best outcome as it would help loosen the link between the sovereign and the banks. It would also represent an important step towards debt mutualisation. But the likelihood of this happening in the near term is an entirely different question.

Credit Suisse notes “The ECB is currently in no mood to continue buying time for politicians. By remaining side-lined it is putting pressure on politicians to conjure up a response. We believe that Spain might succeed in getting an EFSF/ESM credit line dedicated to recapitalising the banking system.

“The risk, however, is that this line needs to be widened to the sovereign if it is shunned by investors concerned about subordination to official creditors. The capacity of the ESM would then be tested.”

In the end, Williams says, “policymakers probably do possess the tools to stabilise markets but are unwilling or unable to use them quickly enough to pacify investors. It is reasonable to argue that current tensions in Spain, the risk of a Greek euro-area exit and the ongoing threat of capital/deposit flight will bring forward the type of policies that might ultimately provide a path out of the current crisis.

“But the story of the last two and a half years is that the policy response normally comes after periods of severe financial-market tension, often reducing its effectiveness.”

Will any good ultimately come from Spain’s banking crisis? Credit Suisse’s bank analysts think so: “The Spanish banking crisis is likely to result in a further step towards a more federal Europe. A banking union accompanied by a supra-national banking supervisory body has been a long-standing item on the ECB’s wish list and is now openly being discussed.”

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