Spain will access a loan from the EFSF/ESM (the eurozone bailout funds) which it will use torecapitalise its ailing banking sector. The money will be channelled through the FROB (theSpanish bank restructuring fund) but will still be a state liability as it will not go directly to thebanks. However, unlike the other bailouts it will not come with fiscal conditions but onlyconditions for reforming the financial sector. The total level of funds needed will be decidedby the Commission, IMF and the ECB – in conjunction with the external stress testsconducted by Oliver Wyman and Roland Berger – as will the exact reforms needed by thefinancial sector.
1. Is the rescue package large enough?
Despite initial relief at the announcement of the Spanish rescue, markets quickly turned thepressure up as questions over the size and structure of the package took hold. In the pasttwo weeks we have seen Spanish borrowing costs increasing across the board, with tenyear bond yields staying above 7% for sustained periods.
1.1 Are the IMF estimates too low?
The most important question relating to the package is whether it will be large enough, and ifso, how much is likely to be tapped. The IMF suggested the needs would be €40bn in anadverse scenario. The Berger/Wyman stress tests put the recapitalisation needs at between€16bn and €62bn. The market estimates mostly fall in the range of €60bn to €90bn. Thereare a number of reasons why the IMF and similar estimates should be considered too low:
The Spanish government has already said that between €30bn and €50bn
will beneeded to recapitalise a few smaller savings banks – between €10bn and €30bn morethan the estimates the recent IMF report for these banks.
The IMF assumes a fall in house prices of 24% over the next two years. However, weexpect it to be closer to 35% (as seen in Ireland). Scaling the IMF estimates up based onthese figures (a reasonable assumption given that most losses will stem from exposureto the bust real estate and construction sectors) suggests that, under our scenario,needs could total closer to €60bn.
Furthermore, the most adverse scenario only sees banks taking a core tier one capitalratio of around 7%. This may suffice for some of the larger stronger banks, but will be toolow for many of the ‘cajas’ (regional banks). This proved to be the case for Bankia, whilein Ireland similar problems hit the Bank of Ireland and AIB which had to increase theircapital ratios to 14% and 18% respectively.
Further extending the IMF’s estimates tomeet a 10% tier one capital ratio, a fair average given the €400bn exposure to the bustreal estate and constructing sectors, would add another €20bn onto the recapitalisationneeds.These are broad strokes, but building upon the IMF figures we would expect the needs tototal between €90bn and €110bn, particularly if they are to secure the banking sector againstfurther downturns in the Spanish economy and a potential worsening of the eurozone crisis(i.e. a Greek exit).
Including, Bankia: €19bn; and CatalunyaCaixa, Banco de Valencia and Novagalicia: €11bn to €30bn This is nota hard and fast threshold above which debt becomes unsustainable but it does generally give a good indicationthat markets are becoming increasingly concerned and the prospect of a self-fulfilling bond run looks possible.
, ‘Bankia going GUBU…but what about the rest’, 28 May 2012:http://ftalphaville.ft.com/blog/2012/05/28/1018331/bankia-going-gubu-but-what-about-the-rest/ The externalstress tests do extend the core tier one capital target to 9%.
These estimates build on our more detailed breakdown of Spanish banking needs provided in our April 2012report, ‘Not so bullish now: the short term prospects for Spain inside the euro’, where we estimated that the loan