Euro area crisis: Spanish banking system bail-out

Spain’s government has finally decided over the week-end to seek international assistance. The precise amount of the loan has yet to be determined but could be up to €100 billion. The following 6 points summarize how the Spanish government will accept EU assistance.

1. The Spanish government has finally decided to seek international aid to address the restructuring of its financial sector.
2. The Eurogroup is willing to respond favourably.
3. The financial assistance would be provided by the EFSF/ESM for recapitalisation of the banking sector.
4. The precise amount of the loan has yet to be determined but could be up to €100 billion.
5. The financial support will be channelled through the Orderly Bank Restructuring (FROB.)
6. No conditionality on fiscal discipline has been attached to the aid. Conditionality of the financial assistance will be focused on reforms targeting the financial sector. 

1. Rajoy avoids severe conditionality
Spanish Economy Minister Luis de Guindos announced on Saturday that Spain’s government intended to request financial assistance from the euro area countries to complete the restructuring of the banking system. Mariano Rajoy has, so far, fiercely resisted the idea of an aid package accompanied by strict conditionality.

This was a purely political question as he considered that the loss of sovereignty implied by conditions linked to the aid package would be politically devastating for its majority. Faced with his European partners’ insistence that he accept aid he managed to get the financial assistance but avoided strict conditionality. 

2. Europe keen to address the Spanish crisis ahead of Greek elections
The Eurogroup has immediately accepted the principle of financial assistance to address the problems of the Spanish banking sector. European authorities were pushing for an agreement ahead of next Sunday’s Greek elections.

3. EFSF or ESM funds, not clear yet
It is not yet clear if the funds will come from the EFSF or the ESM. This will largely depend on the rapidity of the ESM approval process currently underway. The ESM is not supposed to be operational until July.

4. Exact amount to be determined on 21 June
Last Friday, the IMF’s Financial Sector Assessment Program (FSAP) released its conclusion on the Spanish banking system resilience. The FSAP report distinguishes between
– a core of strong banks (i.e. Santander and BBVA) that are well managed, sufficiently capitalised and appear resilient to further shocks; and
– vulnerable institutions with large portions of their balance sheets linked to the real estate sector. A further restructuring and recapitalisation may be needed.

The FSAP conducted stress tests of the banking sector. The findings indicate overall. An additional safety margin could be necessary to cover the costs related to restructuring costs of reclassifying loans.

A more precise evaluation of the loan will be made when the independent audit currently underway is published on 21 June.

5. Assistance channelled through the FROB
The financial assistance to Spain could have been a good opportunity for EU authorities to make a step towards a much needed banking union. But German insistence on maintaining the full responsibility of the Spanish government has the aid has to be channelled through the FROB. The Spanish government will sign a Memorandum of Understanding (MoU).

6. A revamp of the prudential oversight will probably accompany the loan
The IMF FSAP report contains specific recommendations to reform the Spanish banking sector. These could be a base for the conditionality that may be imposed in connection with the EFSF/ESM loan. The key  recommendations are:
– finalise the recapitalisation of banks and implement restructuring plans for banks reliant on state support
– deign and implement a roadmap to deal with banks’ legacy assets
– establish a land and real estate property sale price database
– revamp the prudential oversight in order to avoid inconsistency in the division of responsibilities
– amend legislation to give Banco de España (BdE) operational independence in its supervisory function
– introduce special tools to resolve banks EU assistance will weigh onSpainpublic debt As the financial assistance will be channelled through the FROB, the Spanish government will ultimately be responsible. IfSpaindraws €100 billion for bank recapitalisation, it would add 9pp of GDP toSpain’s gross public debt (69% of GDP in 2011), so still below the current euro area average of 87% of GDP.

Economic recovery remains key to debt sustainability The €100 billion of financial assistance appears to be the upper limit of the needs for the recapitalisation of the Spanish banking sector. But the key to determining whether this step is a turning point in the crisis relies is future economic activity. Delays in adopting corrective fiscal measures at the beginning of the year have postponed a much needed improvement in the public deficit. Economic contraction will weigh on public accounts and delay a stabilisation of the real estate sector and is therefore likely to weigh further on bank balance sheets. Last week-end’s decision is certainly an important step towards resolving the Spanish banking crisis but a complete resolution of the euro area crisis will need further steps towards a mutualisation of the debt. Important announcements are expected at the 28/29 June EU summit.

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