The Eurozone crisis has had a huge impact on the individual Euro countries, and has thrown the future of the Euro currency into question. At the heart of the Eurozone crisis are countries like Greece and Spain. While countries like Portugal and Ireland, have already used a bailout, they have been more successful at shoring up their finances and cleaning up their bank, as opposed to countries like Greece or Spain. So far Greece, Ireland, and Portugal have been the “dominoes to fall”, meaning need a bailout. A lot of financial analysts expect it will be either Spain or Italy to fall next, with Spain looking for the time being like the more probable candidate.
While the Spanish government is doing everything it can to not need a bailout, there are few options it can really take. The austerity measures are already biting on the Spanish economy, with the increase in the unemployment rate and the subsequent increase in protests. The only thing that Spain can really do, is keep the financial system stable and the international markets calm enough for the government to weather the crisis. By keeping the financial system stable, the government can automatically keep financial markets calmer and more lenient on Spanish bonds as opposed to what happened with Greek bonds. The key to keeping the financial system stable is to make sure all the banks are properly capitalized and functioning. The reason bank capital is so important, is because the amount of capital a bank holds is the best way that you can tell if the bank is healthy or not. The capital of a bank, is essentially its assets minus its liabilities. So if a bank has a low amount of capital, then that basically means that the bank has fewer assets to cover its liabilities. In addition, depending on how the economy is doing, the liabilities of a bank can increase. Meaning, that if a bank held a safe loan, but the borrower unexpectedly lost his or her job because of the economy, that safe loan is now a liability. So that is why governments around the world are demanding that banks hold more capital, so that the banks are better capable of managing any potential losses that might come up if the global economy continues to do poorly.
Spain is in that situation, where its economy is suffering tremendously from the Eurozone crisis as well as its domestic housing market. A lot of Spanish banks, do not have enough capital to cover these losses, which could increase if the Spanish economy continues to do poorly. If a country has unhealthy banks, then its economy cannot function properly, because banks cannot lend as much credit into the economy. As any economist will point out, credit is the lifeblood of any industrial economy. Which is why the article talks about how the Spanish government is struggling to recapitalize of the largest Spanish banks. The bank is called Bankia, which is owned by a large finance company called Banco Financiero y de Ahorros. Both the banks and the financial holding company have about 55 billion euros worth of bad assets on their balance sheets. As a result, the combined group faces more than 3 billion euros worth of a capital shortfall. One of the solutions that the government had proposed was a sector-wide “bad bank”. What that means is that the government would set up a separate bank that it would own, and that bank would buy all the bad assets from all the Spanish banks. Essentially, cleaning up the Spanish banks balance sheets, and protecting them from any losses. This would put the Spanish taxpayer on the hook for any losses that the loans would produce. However, just like the bad bank would protect from losses, it would also deprive of any potential gains. For example, if the Spanish economy started to perform very well again, then the bad loans might be worth a lot more again, because borrowers would have the ability to pay back. So the bad bank would be a double-edged sword.
Which is why the biggest Spanish banks, BBVA and Santander have pushed the Spanish government to find a different solution to the crisis rather than making them give up what look like bad assets right now, but what could be worth a lot more later. However, the CEO of Bankia had been hoping for a bad bank to help Bankia get rid of its bad assets, so that Bankia could start functioning normally again. But the Spanish government has decided to use different provisions, to help out Bankia. The CEO of Bankia resigned, since Bankia had a IPO not long ago and already the bank is running into huge trouble. As a result, it is likely that Bankia will end up merging with its finance company BFA. As the article points out though, the Spanish government has to make sure that Bankia does not put a bad light on the rest of the Spanish banking sector. Since, no one really knows just how bad are the losses that all of the Spanish banks are looking at, because of the bad assets on the balance sheets. One way the Spanish government could restore market confidence in Spanish banks, is by demanding that the banks disclose all their potential losses and make sure that the banks take better provisions to take care of these losses. In addition, the Spanish government should stand by ready to inject capital into the banks, in case the banks cannot raise it themselves. It’s all easier said than done.
The liabilities that the Spanish banks are looking at are huge. According to the article, all the Spanish banks are looking at a combined 323 billion euros of bad assets on their balance sheets. The banks have provision to cover approximately 38% of these bad assets, but the article says that they need to have enough capital to cover 60% of these bad assets. Which will mean that the banks collectively need 80 billion euros of capital to bring up the provision percentage. Which is clearly a lot of money, and may be beyond what the Spanish government can provide by itself. As the article ends by saying, “That may mean Madrid is forced to look to its European partners to provide the funds. But that must not be a reason to duck the issue.”