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Disaster recovery

20 April 2012 By Fiona Maharg-Bravo, Peter Thal Larsen

Spain’s banks are once again in the eye of the storm. Though the sector has undergone consolidation and raised fresh capital, most lenders are still shut out of wholesale markets. Concerns about banking contagion are one reason Spanish bond yields are in the danger zone once more. Disaster insurance, underwritten by the euro zone, could help take the issue off the table.

Banks haven’t been sitting on their hands. They have made bad debt provisions worth 112 billion euros, according to the Bank of Spain, and will set aside a further 29 billion euros against commercial real estate this year. Core capital ratios have been boosted to at least 8 percent. Meanwhile, mergers should help restore profitability: the number of former savings banks has shrunk from 45 to 11.

But investors aren’t convinced. Though banks are prepared for an 87 percent drop in the price of undeveloped land from the peak, the worry is that values will fall even further. Meanwhile, Spain’s shrinking economy could put pressure on mortgages and small business loans, which have held up to date. A one percentage point increase in provisions on loan portfolios – excluding real estate – would force banks to come up with about 16 billion euros in extra provisions, or more than 10 percent of their current tangible equity, according to Exane BNP Paribas.

One way to repair confidence would be to insure Spanish banks against extreme losses. This approach helped to calm fears about Royal Bank of Scotland and Citigroup during the banking crisis. If the Bank of Spain is right about banks’ resilience, the scheme wouldn’t cost taxpayer money. If the worst happens, banks have a backstop.

The key question is how such a scheme would be funded. Spain’s Deposit Guarantee Fund, which is financed by the industry, could provide some financing. Though the DGF has almost run out of money, it can raise funds by borrowing against future contributions, which bring in 2 billion euros a year. The Spanish government could also absorb some losses.

But to be credible, the insurance scheme would need a backstop from the European Financial Stability Facility. The euro zone bailout fund is permitted to lend to countries for the purpose of recapitalising banks – which could be defined as including balance-sheet guarantees. The advantage of providing insurance is that it would not need to raise the funds up front.

Bullet-proofing banks would not solve all of Spain’s problems. The country still faces an uphill struggle to meet its budget deficit target this year and next, and bringing the regions into line. But at least the banks would stop being the Achilles’ heel.


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