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One size does not fit all

26 October 2011 By Fiona Maharg-Bravo

Europe’s bank recap exercise misses the point in Spain. EU governments are hoping to restore confidence in the financial system by forcing lenders to clear a higher capital hurdle after recognising potential losses on sovereign debt. But the problem with Spanish banks is their exposure to real estate, not government bonds.

Though final details are still being hammered out, the EU’s latest demands should be manageable for Spain, which forced tougher capital ratios on its banks earlier this year. Many lenders’ core Tier 1 capital ratios are already near the 9 percent demanded by European regulators – though this does assume that convertible bonds count towards the total.

Marking sovereign bonds to market also shouldn’t be too stressful. True, the Spanish banks that participated in July’s Europe-wide stress tests have net exposure to the country’s debt of 222 billion euros. But based on current prices for 5-year debt, the implied haircut is just 4.4 billion euros. Besides, it looks like smaller banks will escape the test: only Spain’s five biggest lenders will have to comply with the new demands, Reuters reported on Oct. 25.

Real estate is a different story. Lenders still have large exposures to developers and are sitting on billions of euros of foreclosed properties. The banking system has already set aside 105 billion euros against bad loans, and Spain’s bailout fund has so far injected 17.6 billion euros into the country’s savings banks. But given the deteriorating economic climate, there is a fairly broad consensus that existing provisions will not cover potential losses.

In theory, every euro of extra capital helps to cope with future writedowns. But the recapitalisation gives no incentive to clean up real estate loans. Indeed, higher capital requirements could impede further consolidation in the Spanish market, because it will shrink big banks’ capacity to buy failed savings banks.

The point of Europe’s recap exercise is to restore confidence in banks and allow them to once again start financing themselves in the wholesale market. Resolving the sovereign debt crisis would clearly help Spain, and by extension its banks. But it won’t resolve doubts about possible future real-estate losses in Spain.


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